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

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.