Small-sized companies’ earnings management: evidence from Italy

This study explores the earnings management practices of small-sized Italian companies. Adopting the earnings distribution approach, it finds that these companies are likely to manage their earnings to achieve two earnings level targets. On the one hand, they manage their earnings to report slightly positive earnings. Those with negative earnings manage them upward to be above the zero threshold. Those with positive earnings manage them downward to bring them close to zero. On the other hand, they manage their earnings to minimize earnings changes. The main implication of the findings of this study is that the small-sized Italian companies’ earnings are not unconditionally informative regarding their performance. In other words, they are of poor quality. As a result, they should be interpreted with caution by those who use financial statement information. This study mainly enriches the literature on earnings management in two ways. Firstly, it provides evidence on small-sized companies’ earnings management practices which are very little explored in literature. Secondly, it provides additional evidence on the earnings management practices undertaken in the Italian setting, and so in countries which are characterized by a code law system and a close alignment between accounting and tax systems.