From accruals to real activities: Understanding the trade-off in earnings management choices amid XBRL adoption in Italy

Abstract

This study examines the factors influencing managerial decisions between accrual-based earnings management (AEM) and real earnings management (REM) following the mandatory adoption of eXtensible Business Reporting Language (XBRL) among firms listed on the Italian stock exchange. By analyzing the shift between AEM and REM, the research provides insights into how enhanced financial reporting transparency affects managerial decision-making. The study employs an empirical analysis of Italian firms to assess the relationship between XBRL adoption and earnings management practices. The research investigates the extent to which firms adjust their earnings management strategies in response to increased transparency, with a specific focus on the trade-off between AEM and REM. The results indicate  that mandatory XBRL adoption is associated with a decline in accrual-based earnings management (AEM) and a corresponding increase in real earnings management (REM) among Italian firms. The findings suggest that increased financial reporting transparency prompts firms to rely more on REM while simultaneously reducing their use of AEM. Additionally, the intensity of the trade-off between AEM and REM is found to be positively moderated by firms classified as SUSPECT, which are those reporting only small positive profits or slight increases in profitability. These firms would likely have experienced losses or declining profitability without the use of earnings management tools, with a stronger tendency to rely on AEM over REM. However, this moderating effect was not observed among loss-making (LOSS) firms. This study makes two key contributions. First, it is among the first to examine the impact of XBRL implementation on earnings management practices within a European context, specifically in Italy. Second, it provides novel insights into the factors influencing the trade-off between AEM and REM, addressing an important gap. The findings highlight the unintended consequences of financial reporting standardization, demonstrating that increased transparency may shift earnings management strategies rather than eliminate them. Regulators and policymakers should consider these effects when designing financial disclosure regulations to mitigate potential opportunistic behavior by firms.