Earnings Management and Privatizations: Evidence from Pakistan

This study examines the incidence of earnings management around the privatizations of State Owned Enterprises in Pakistan during 1991-2005. Using the modified Jones model and a sample of large privatizations (minimum US$1 million), it shows that the sampled firms experienced increase in earnings, decrease in cash flows, and increase in current discretionary accruals in the year prior to and/or in the year of privatization. The SOEs used both short term and long term accruals to inflate reported earnings. These accruals got reversed in the post-privatization period. These findings suggest that managers of the firms under privatization were engaged in earnings management to inflate their firms’ financial worth to maximize the privatization proceeds. Hence, we cannot reject the incidence of earnings management around privatizations in Pakistan. The results imply that the investors should carefully evaluate the to-be-privatized firms and keep in view the possibility of earnings management by the SOEs.