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Regulating Competition in Stock Markets: Antitrust Measures to Promote Fairness and Transparency through Investor Protection and Crisis Prevention by Michael Wang, Viktoria Dalko, Lawrence Klein

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Chapter 5

Preventing Stock Market Crises (III)

Regulating Earnings Manipulation

Xin Yan

Lawrence R. Klein

Viktoria Dalko

Ferenc Gyurcsány

Michael H. Wang1

Earnings manipulation is inconsistent with the concept of perfect competition that is fair and transparent in stock markets. Earnings manipulation has been pervasive and persistent in the United States for the past 50 years. Research turns increasingly to international evidence and cross-market comparison. Enron, WorldCom, Lehman Brothers, and a series of corporate financial scandals have repeatedly shown securities regulators and investors the destructive consequences of earnings manipulation. The Sarbanes-Oxley Act (SOX) responded quickly to curb accrual-based earnings manipulation. Real earnings manipulation increased substantially and persisted in the post-SOX era with intensity similar to that in the pre-SOX era. More fundamental than earnings manipulation per se, there are multiple causal factors that have not been carefully considered or thoroughly regulated. They include the marketing assistance and performance pressure exerted by securities analysts that prompt corporate managers to manipulate financial statements, given lax detection by auditors, off-target regulatory penalties, and incentives that encourage managers to manipulate earnings. This chapter, joining the effort to draft measures to regulate corporate insiders and security analysts, attempts to address the unfinished mission to eliminate this poor conduct. ...

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