Non-profit organizations are generally perceived to not have profit maximization as their operational goal because profit is not their critical concern . The goal of non-profit hospitals is also not to create profit, but interested parties or stakeholders (creditors, communities, responsible authorities, donors, and third-person related parties) use earnings to evaluate hospital performance nonetheless . Thus, managers of non-profit hospitals must consider the organization’s financial performance .
 defined earnings management as managers use of judgment in financial reporting and in structuring transactions to alter financial reports either to mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers. Additionally, many NFP hospitals are known to adjust discretionary accruals      and manipulate real activities     . NFP hospitals have also been reported to implement accounting adjustments to prevent minor losses       , break even , near zero  , reduce earnings  , and prevent large positive net incomes . A relevant concern in NFP hospital financial reporting is the extent to which managers manipulate reported earnings.
Most of non-profit hospitals in Taiwan (especially medical centers or institution-owned Hospitals) have positive net income and even more than other industries . It is a serious puzzle; thus, how can a hospital’s real performance be determined? It is a complex problem, especially because a hospital’s real performance influences not only the employees but also the creditors, communities, responsible authorities, donors, and related third parties. Moreover, there are several factors for which the Department of Health, Executive Yuan (
2. Literature Review and Hypothesis
 suggested that auditors with industry expertise are more likely to detect misrepresentations and irregularities than are auditors without industry expertise, especially in the early years of the audit assignment. The link is based on the assumption that industry specialist auditors have industry expertise and have a clear understanding of the client’s business. Furthermore, industry specialist auditors who accumulate industry-specific knowledge can improve audit quality, identify and detect errors or misstatements , and comply with auditing standards . Therefore, hiring an auditor with industry specialization can help limit earnings management because of the enhanced financial reporting quality    .
H1: Auditor specialization has a negative correlation with earnings management.
 determined longer auditor tenures could lead to friendlier relationships with the management, which might impair auditor independence.  indicated two arguments supporting the hypothesized relationship between auditor tenure and financial reporting quality: the “independence effect”—a longer tenure increases the likelihood that personal relationships between auditors and clients develop to a depth sufficient to impair audit independence; and the “familiarity effect”—a longer tenure may induce complacency in the auditor, reducing the likelihood that errors and irregularities are detected. Thus, auditor tenure is associated with a high probability of using earnings management  .
H2: Auditor tenure has a positive correlation with earnings management.
The sample for this study was obtained from the Department of Health, Executive Yuan, and NFP hospitals between 2013 and 2017 (sample size = 240). NFP hospitals in Taiwan are classified as being in the following sectors: Medical centers (15 hospitals, 75 samples) and institution-owned hospitals (33 hospitals, 165 samples). This study also adopted the ordinary least squares (OLS) method. An OLS model was employed to analyze the data variables and research model used for this study; the results are described as follows.
3.1. Dependent Variable: Discretionary Items (DIit)
where is the change in bad debt expenses for year t; is the change in net revenue for year t; is the change in Medicare revenue (collected by hospitals through national medical insurance) for year t; is the change in Medicaid revenue for year t:
where = change in non-operating or non-revenue-generating activity expenditure for t − 1 to t; if pre-management income/total assets are within or above the benchmark range (income/total assets [0,0.04]) for year t, and 0 otherwise; if pre-management4 income/total assets exceed the benchmark range (income/total assets [0,0.04]) for year t, and 0 otherwise; = if pre-management5 income/total assets are below the benchmark range (income/total assets [0,0.04]) for year t, and 0 otherwise; = log of the total assets for year t; = change in medical revenue from t − 1 to t; if the hospitals reports a net gain on the sale of property in year t, 0 otherwise; if pre-managed6 income/total assets are to the left of the benchmark range (income/total assets < 0.0) for year t, 0 otherwise; if pre-managed7 income/total assets are to the left of the benchmark range (income/total assets ≥ 0.04) for year t, 0 otherwise; and = gross property, plants, and equipment for year t − 1. Discretionary items have been frequently used in previous studies as a proxy for earnings management, for which the value of for measuring earnings management has been adopted. Where, the absolute value of to measure earnings management were adopted.
3.2. Independent Variable
The study used the regression method. The proxy variables are as follows: is the number of clients the auditor worked for in year t  8; is the number of years an auditor has worked for the same client in year t  9.
3.3. Control Variable
The study defines the following proxy variables are as follows. DEBTit is the proportion of debt at time t measured in liabilities divided by assets × 100%  ; OCFit is operating cash flow measured as at time t  ; NAit is net asset at time t measured in assets minus liabilities .
4.1. Descriptive Statistics
According to the descriptive statistics analysis in Table 1, the mean of proportion of debt at 47.32% shows it to be financial conservative. Net assets show that not profit hospitals in Taiwan are 162.55 (U.S. million dollars). Operating cash flows show that non-profit hospitals in Taiwan are profitable and doing well.
4.2. Empirical Test
Tables 2-4 present descriptive statistics for the discretionary item models. We adopted three models to measure abnormal real discretionary items (BD model,
Table 1. Descriptive statistics for variables (US dollars in millions, %, points).
is the number of clients the auditor worked for in year t; is the number of years an auditor has worked for the same client in year t. is the proportion of debt at time t measured in liabilities divided by assets ×100%; is operating cash flow measured as at time t; is net asset at time t measured in assets minus liabilities.
Table 2. Descriptive statistics for the estimated cross section: BD-model.
*: p < 0.1; **: p < 0.05; ***: P < 0.01.
Table 3. Descriptive statistics for the estimated cross section: NORR-model.
*: p < 0.1; **: p < 0.05; ***: P < 0.01.
Table 4. Descriptive statistics for the estimated cross section: NGSP-model.
*: p < 0.1; **: p < 0.05; ***: P < 0.01.
The empirical results in Table 5 show that auditor specialization and earnings management had a significant, negative relationship. This indicates that auditors who have a specialist’s knowledge of the industry can improve audit quality; therefore, hiring an auditor who is an industry specialist helps limit earnings management. As previous literature in accounting and finance has demonstrated the effectiveness of the auditors in preventing earnings management. We are able to interpret the measures in terms of monitoring intensity. Because these auditors have industry expertise contributes to auditor independence. Besides it, they may focus on these auditors face greater risk of litigation and reputational damage when accruals or real activities earnings management is increased. Therefore, H1 was supported, which is consistent with the findings of    .
Auditor tenure and earnings management had a significant, negative relationship. This shows that, as auditor tenure increases, the auditor progresses at assessing the risk of material misstatements by gaining experience and improved insight into the client’s operations, business strategies, and internal controls over financial reporting. Therefore, the longer the auditor tenure is, the lesser the earnings management behaviors of nonprofit hospitals in Taiwan. Thus, H2 was not supported, which is inconsistent with the findings of  and . Table 5 also shows how analyzing the discretionary items of abnormal net gain on the sale of property is a powerful method for explaining earnings management. It also shows that the discretionary items of abnormal net gain on the sale of property accruals is a suitable index for explaining earnings management in Taiwanese NFP hospitals. In addition, the variance inflation factors10 of variables were smaller than 10 in our logistic model, indicating that the related variables were not collinear.
Table 5. Regression results.
*: p < 0.1; **: p < 0.05; ***: P < 0.01.
The objective of this study was to determine whether earnings management is employed by NFP hospitals in Taiwan and to analyze their earnings management behavior. The samples obtained spanned 2013 to 2017. This study used the ordinary least square method to examine the relationships in Taiwan’s nonprofit hospitals, and also developed and tested alternative procedures, such as the BD, NORR, and NGSP models, to measure abnormal real items. Research has indicated that the longer the auditor tenure and the more specialized the auditor, the lower the likelihood is that the discretionary accruals of bad debt, the discretionary accruals of the net gain on property sales, and the discretionary accruals of non-operating or non-revenue-generating activity are adopted as earnings management. NFP hospitals in Taiwan are not required to disclose governance-related information, which results in inadequate governance mechanisms and allows managers to manipulate earnings easily. Therefore, we recommend that the Department of Health, Executive Yuan adopt stricter systems to increase the disclosure of internal governance information. Moreover, because auditor specialization has a negative relationship with earnings management, we also suggest that the government establish the evaluation of certified public accountants who have audited hospitals. A list of qualified accountants should be provided to nonprofit hospital managers, and the number of hospitals audited by each auditor should be limited to maintain the level of audit quality.
Finally, auditor tenure has a negative relationship with earnings management. Our results did not show that auditors’ judgment has been impaired because of independent relationships with Taiwan’s nonprofit hospital managers (auditor tenure has a positive relationship with earnings management). Therefore, the government should establish a mandatory auditor rotation rule (according to which auditors are replaced after a certain number of years of auditing the same client) or a dual signer system (in which two auditors are required to sign each financial statement) to prevent impaired audits in the future. The results can provide a reference for policy makers interested in promoting legislation to ensure strong governance in Taiwanese NFP hospitals. The study also suggests that future studies examine the impact factors of earning management in other kinds of hospitals, because different hospitals have different organizational structures or cultural. In addition, other elements such as market competition and the compensation of directors and supervisors must be considered. Subsequent research should keep track of these trends and analyze the degree of earnings manipulation.
Our study has forth main limitations. First, while certain features of our research design mitigate the possibility that our results are driven by endogeneity, it is not possible for us to definitively rule out endogeneity as an alternative explanation of our results. Second, while auditor specialization and auditor tenure are a useful tool in defining in various the auditor characteristics attributes, these variables may not have readily interpretable economic meaning. Third, we document that firms use real, as well as accrual-based, earnings management methods around non profits hospitals in Taiwan, which were used to measure earnings manipulation, necessitates further research. Fourth, because of limited data availability, the findings cannot be generalized to all of not profit hospitals in Taiwan. These limitations should be kept in mind in interpreting our results.
4We begin by calculating net income before spending on non-operating or non-revenue-generating activity .
5We begin by calculating net income before spending on non-operating or non-revenue-generating activity .
6We begin by calculating net income before net gain on property sales activity .
7We begin by calculating net income before net gain on property sales activity .
10The results were omitted to save space.