Earnings management in public healthcare organizations: the case of the English NHS hospitals

ABSTRACT

This paper explores whether NHS hospitals in England managed their earnings upward before applying to the government for foundation trust (FT) status—a scheme that allowed them greater financial freedom and management autonomy—in order to present an overly positive picture and increase their chances for a successful application. The paper shows that NHS FTs adjusted discretionary accruals upward for up to two years before applying for FT status. This practice was negatively associated with their future financial performance. Our study contributes to the growing literature on earnings management in the healthcare sector, by taking an event-study approach applied to this sector when significant institutional changes take place.

IMPACT

This analysis shows that prospective English NHS foundation trusts (FTs), in anticipation of institutional reforms granting them significant freedoms, engaged in income-increasing earnings management more intensely than did NHS trusts that never attained this status. The authors also provide evidence that earnings management is associated, at least partly, with the future underperformance of NHS FTs, confirming an untested hypothesis in the literature. Hence, incentives that the state provides to public organizations can have a significant effect on their behavior—much like in the private sector. The authors call for improved incentive designs by standard-setting (for example CIPFA) and regulatory bodies to prevent unintended consequences in the process of designing optimal healthcare policies.

KEYWORDS:

• Earnings management
• financial performance
• healthcare
• hospitals
• institutional transition
• NHS foundation trusts

Acknowledgements

We would like to thank Public Money & Management’s Deputy Editor, Professor Andreas Bergmann, and two anonymous reviewers, for very helpful comments and suggestions, which greatly improved the paper. We are grateful to John Forker, Georgia Marini, Estela Balboas, Karen Bloor, and Seunghan Nam for constructive comments and suggestions on previous versions of the manuscript. We would also like to thank participants at the City Health Economics Centre (CHEC) seminar in London UK; the Health Economists Study Group (HESG) 2016 meeting, Gran Canaria, Spain; the European Health Policy Group (EHPG) Autumn 2016 meeting, London, UK; the British Accounting and Finance Association (BAFA) 2017 meeting, Edinburgh, UK; the European Accounting Association (EAA) 2017 conference, Valencia, Spain; and the European Financial Management Association (EFMA) 2017 conference, Athens, Greece, for useful feedback on early versions of the paper. We are particularly thankful to three CEOs and one finance director of English hospitals, and also to an audit partner of a Big4 audit firm, for providing very insightful information on their experiences from FT application processes and financial reporting procedures in the English NHS. Any remaining errors are our own responsibility. This work was partially supported by City, University of London

Disclosure statement

No potential conflict of interest was reported by the author(s).