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Earnings management in the electric utility industry: profit incentives

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Abstract

Electric utilities face profit regulation tied explicitly to accounting data. Under existing rate structure, the utilities are required to provide periodic and specialized accounting reports for use in rate decisions. Consumer groups and opponents often criticize the rate structure alleging possible alteration of accounting reports by utilities to gain favorable regulation. Nonetheless, there is little empirical evidence supporting the allegation. This study investigates profit incentives for earnings management by utilities seeking rate increases. Specifically, this study investigates whether electric utilities proactively adopt profit-reducing actions before and during rate requests. The results are consistent with strategic use of accounting methods to reduce reported profits immediately before and during rate requests. The evidence supports the notion that utilities reduce profits just before and during rate reviews to relax regulatory constraints and improve profit opportunities.

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Notes

  1. The analysis in these papers primarily focuses on banks and financial institutions. See also, Moyer 1990; Beatty et al. 1995; Collins et al. 1995; and Scholes et al. 1990.

  2. The shock to the oil industry in the 1970s demonstrated the ineffectiveness of traditional regime in controlling costs. During the period, the OPEC oil embargo led to high production costs for utilities. As a result, utility rates rose sharply, prompting public demand for greater accountability by utilities.

  3. FERC certifies two classes of generators as qualifying facility (QF) to gain the PURPA benefits: a small power producer and a cogenerator. A qualifying small producer is determined with reference to fuel use, efficiency, and reliability. Cogeneration is the dual production of both electric energy and steam.

  4. We conducted analysis on ROE, and the results are similar to those of ROA, supporting the hypothesis 1.

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Acknowledgments

The paper benefited from comments and suggestions by two anonymous reviewers, Sharad Asthana, Jeff Boone, Dana Forgione, Jim Groff, Carlos Jimenez, participants, discussants, and anonymous reviewers at the 2012 American Accounting Association Annual Meeting, and workshop participants at Rutgers University and the University of Texas-San Antonio. Financial support for the Project was provided by the College of Business and Entrepreneurship at Texas A&M University Commerce and by the College of Business at the University of Texas San Antonio.

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Authors and Affiliations

  1. Department of Accounting, College of Business, Texas A&M University Commerce, 2200 Campbell St., Commerce, TX, 75428, USA

    Shiyou Li

  2. Department of Accounting, College of Business, University of Texas at San Antonio, One UTSA Circle, San Antonio, TX, 78249, USA

    Emeka Nwaeze & Jennifer Yin

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  1. Shiyou Li
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  2. Emeka Nwaeze
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  3. Jennifer Yin
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Correspondence to Shiyou Li.

Appendix

Appendix

See Table 12.

Table 12 Variables definition (WRDS mnemonics for compustat variables are in parenthesis)
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Li, S., Nwaeze, E. & Yin, J. Earnings management in the electric utility industry: profit incentives. Rev Quant Finan Acc 46, 633–660 (2016). https://doi.org/10.1007/s11156-014-0481-1

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