Overvaluation and the Choice of Alternative Earnings Management Mechanisms

2011 ◽  
Vol 86 (5) ◽  
pp. 1491-1518 ◽  
Author(s):  
Brad A. Badertscher
Keyword(s):  
Earnings Management ◽  
Important Determinant ◽  
Data Availability ◽  
Present Evidence ◽  
Accruals Management ◽  
Early Stages ◽  
Jel Classifications

ABSTRACT In this study I examine how the degree and duration of overvaluation affect management's use of alternative within-GAAP earnings management, restrictions on further exploitation of within-GAAP accruals management, and subsequent non-GAAP earnings management. Further, I examine how one type of earnings management segues into another type as overvaluation persists. I present evidence that the longer the firm is overvalued, the greater is the amount of total earnings management. I also find that managers engage in accruals management in the early stages of overvaluation before moving to real transactions management, in order to sustain their overvalued equity. Finally, I find that the longer a firm is overvalued, the more likely it is to engage in one of the most egregious forms of earnings management, non-GAAP earnings management. Collectively, the results suggest that the duration of firm overvaluation is an important determinant of managements' choice of alternative earnings management mechanisms. JEL Classifications: M41, M43, M44. Data Availability: Data are available from sources identified in the text.

Clawbacks and Earnings Management

2018 ◽  
Vol 31 (3) ◽  
pp. 129-151 ◽  
Author(s):  
Carolyn B. Levine ◽  
Michael J. Smith
Keyword(s):  
Numerical Analysis ◽  
Earnings Management ◽  
Cash Flows ◽  
Data Availability ◽  
Real Earnings Management ◽  
Interim Report ◽  
Short Term ◽  
Period Model ◽  
Jel Classifications

ABSTRACT This study addresses the effect of clawbacks on earnings management (EM). In a two-period model, the manager can report truthfully or distort an interim report using either accrual or real EM. The principal can make short-term payments based on a manipulable accounting signal and long-term payments based on unmanipulable cash flows. The strength of the clawbacks determines the likelihood that the manager's compensation is reclaimed when the interim report was managed. Stronger clawback provisions may result in (1) a substitution between accrual and real earnings management, or (2) earnings management when no earnings management was optimal with weak clawbacks, and (3) lower expected profits for the principal. Numerical analysis suggests that strong clawbacks do not reduce aggregate earnings management. JEL Classifications: J33; M48; M52; G38. Data Availability: All data are simulated.

Capital Structure, Earnings Management, and Sarbanes-Oxley: Evidence from Canadian and U.S. Firms

2013 ◽  
Vol 27 (2) ◽  
pp. 301-318 ◽  
Author(s):  
Kelly E. Carter
Keyword(s):  
Capital Structure ◽  
Earnings Management ◽  
Data Availability ◽  
Cost Of Debt ◽  
Equity Financing ◽  
Percentage Points ◽  
Sarbanes Oxley ◽  
The U.S ◽  
Jel Classifications

SYNOPSIS I examine Sarbanes-Oxley's (SOX) effect on capital structure. I find that SOX is associated with higher long-term debt ratios, as firms listed in the U.S. raise their long-term debt ratios by 2 to 3 percentage points. This finding is consistent with the idea that, although the reduction in information asymmetry associated with SOX could prompt managers to increase equity financing, debt is still safer and less costly than equity in the SOX era. Further analysis shows that the increase in debt occurs in the two quarters prior to SOX, suggesting that firms anticipate a higher cost of debt after SOX and acquire debt while it is relatively cheap. Also, firms that heavily (lightly) manage earnings prior to SOX use less (more) debt after SOX. This result is consistent with the view that firms that aggressively manage earnings before SOX reveal intrinsically weaker earnings after SOX, casting doubt on those firms' ability to repay debt and relegating those firms to issue equity for financing purposes. JEL Classifications: G32; G38. Data Availability: Data available upon request.

Irregularities in Accounting Numbers and Earnings Management—A Novel Approach Based on SEC XBRL Filings

2015 ◽  
Vol 12 (1) ◽  
pp. 117-151 ◽  
Author(s):  
Klaus Henselmann ◽  
Dominik Ditter ◽  
Elisabeth Scherr
Keyword(s):  
Earnings Management ◽  
Financial Analysis ◽  
Human Interaction ◽  
Data Availability ◽  
Analysis Approach ◽  
Financial Reports ◽  
Novel Approach ◽  
Accounting Numbers ◽  
Fully Automatic ◽  
Jel Classifications

ABSTRACT The SEC XBRL mandate enables the gathering of accounting numbers to be fully automatic in a database-like manner that provides vast opportunities for financial analysis. Using this functionality, this study proposes a simple analytical prescreening measure that uses abnormal digit distributions at the firm-year level to identify firms suspected of having managed earnings. On average, we find that the constructed measure indicates a greater amount of irregularities in the reported accounting numbers of firms with higher incentives to engage in earnings management. The suggested XBRL-enhanced digit analysis approach may provide the SEC and investors a simple measure to flag financial reports carrying a higher probability of human interaction. JEL Classifications: C10; M41; M43. Data Availability: Data used in this paper are publicly available. The analytical prescreening VBA-Tool is available upon request. A description of the tool is available; see Appendix B.

scholarly journals Board Interlocks and Earnings Management Contagion

2012 ◽  
Vol 88 (3) ◽  
pp. 915-944 ◽  
Author(s):  
Peng-Chia Chiu ◽  
Siew Hong Teoh ◽  
Feng Tian
Keyword(s):  
Earnings Management ◽  
Audit Committee ◽  
Data Availability ◽  
Contagion Effect ◽  
Financial Reports ◽  
Committee Chair ◽  
Endogenous Matching ◽  
Board Monitoring ◽  
Jel Classifications

ABSTRACT We test whether earnings management spreads between firms via shared directors. We find that a firm is more likely to manage earnings when it shares a common director with a firm that is currently managing earnings and is less likely to manage earnings when it shares a common director with a non-manipulator. Earnings management contagion is stronger when the shared director has a leadership or accounting-relevant position (e.g., audit committee chair or member) on its board or the contagious firm's board. Irregularity contagion is stronger than error contagion. The board contagion effect is robust to controlling for endogenous matching of firms with directors, fixed firm/director effects, incidence of M&A, industry, and contagion via a common auditor or geographical proximity. These findings support the view that board monitoring plays a key role in the contagion and quality of firms' financial reports. JEL Classifications: M40; M41; M49; G34; G39; D83. Data Availability: Data are available from sources identified in the text.

Revenue Recognition, Earnings Management, and Earnings Informativeness in the Semiconductor Industry

2012 ◽  
Vol 27 (1) ◽  
pp. 91-112 ◽  
Author(s):  
Stephanie J. Rasmussen
Keyword(s):  
Earnings Management ◽  
Semiconductor Industry ◽  
Distribution Channel ◽  
Life Cycles ◽  
Data Availability ◽  
Revenue Recognition ◽  
Product Life ◽  
Product Life Cycles ◽  
Product Return ◽  
Jel Classifications

SYNOPSIS Manufacturers that sell products to distributors experience product return and pricing adjustment uncertainties until the products are resold to end-customers. Such manufacturers recognize revenue when products are delivered to distributors (sell-in), when distributors resell products (sell-through), or under some combination of these methods (sell-in for some distributor sales and sell-through for others). This study examines the implications of these revenue recognition methods for a sample of semiconductor firms during 2001–2008. Semiconductor firms face rapid product obsolescence, declining prices over product life cycles, and unexpected industry downturns, which naturally lead to product return and pricing adjustment uncertainties. I find that sell-through and combination firms are less likely to manage earnings compared to sell-in firms. I also find that earnings are more informative for sell-through firms compared to both sell-in and combination firms. These findings suggest that manufacturers that sell products through the distribution channel should defer revenue recognition until product return and pricing adjustment uncertainties are resolved. JEL Classifications: M41 Data Availability: Data are available from the sources identified in the text.

An Analysis of Managerial Use and Market Consequences of Earnings Management and Expectation Management

2011 ◽  
Vol 86 (6) ◽  
pp. 1935-1967 ◽  
Author(s):  
Somnath Das ◽  
Kyonghee Kim ◽  
Sukesh Patro
Keyword(s):  
Earnings Management ◽  
Stock Price ◽  
Structural Models ◽  
Data Availability ◽  
Expectation Management ◽  
Earnings Targets ◽  
Market Consequences ◽  
The Relationship ◽  
Jel Classifications

ABSTRACT This study examines how managers coordinate the joint use of earnings management and expectation management by estimating the relationship between these instruments and how this relationship changes as their respective constraints change. We do this by estimating structural models of the two instruments that account for the constraints on their use as well as their effects on each other. Our results suggest that managers use earnings management and expectation management complementarily when managers' ability to use earnings management is less restricted. However, as the constraints on earnings management increase, managers substitute earnings management with expectation management. Moreover, we find that the extent of expectation management influences the extent of earnings management, but not vice versa. Examining the market consequences of the use of these instruments, we find that, while there are penalties for using both earnings management and expectation management, either as complements or as substitutes, the net stock price benefit from meeting or beating earnings targets exceeds these penalties. JEL Classifications: G14; M41. Data Availability: Data are available from public sources identified in the study.

Substitution between Real and Accruals-Based Earnings Management after Voluntary Adoption of Compensation Clawback Provisions

2014 ◽  
Vol 90 (1) ◽  
pp. 147-174 ◽  
Author(s):  
Lilian H. Chan ◽  
Kevin C. W. Chen ◽  
Tai Yuan Chen ◽  
Yangxin Yu
Keyword(s):  
Earnings Management ◽  
High Growth ◽  
Data Availability ◽  
Short Term ◽  
Financial Reports ◽  
Accruals Management ◽  
Earnings Information ◽  
Financial Misstatements ◽  
Earnings Targets ◽  
Voluntary Adoption

ABSTRACT To deter financial misstatements, many companies have recently adopted compensation recovery policies—commonly known as “clawbacks”—that authorize the board to recoup compensation paid to executives based on misstated financial reports. Clawbacks have been shown to reduce financial misstatements and increase investors' confidence on earnings information. We show that the benefits come with an unintended consequence of certain firms substituting for accruals management with real transactions management (e.g., reduce research and development [R&D] expenditures), especially firms with strong incentives to achieve short-term earnings targets, such as firms with high growth or high transient institutional ownership. As such, the total amount of earnings management does not decrease subsequent to clawback adoption. We further show that although real transactions management temporarily boosts those clawback adopters' short-term profitability and stock performance, this trend reverses after three years. In summary, clawbacks may have unexpected effects for a subset of firms whose managers are under greater pressure to meet earnings goals. Data Availability: All data used in the study are publicly available from the sources cited in the text.

Interim Reporting Frequency and the Mispricing of Accruals

2018 ◽  
Vol 32 (3) ◽  
pp. 29-47
Author(s):  
Shou-Min Tsao ◽  
Hsueh-Tien Lu ◽  
Edmund C. Keung
Keyword(s):  
Financial Reporting ◽  
Stock Prices ◽  
Data Availability ◽  
Financial Reports ◽  
Regulatory Changes ◽  
Sample Composition ◽  
Reporting Frequency ◽  
Over Time ◽  
Jel Classifications ◽  
Accrual Mispricing

SYNOPSIS This study examines the association between mandatory financial reporting frequency and the accrual anomaly. Based on regulatory changes in reporting frequency requirements in Taiwan, we divide our sample period into three reporting regimes: a semiannual reporting regime from 1982 to 1985, a quarterly reporting regime from 1986 to 1987, and a monthly reporting regime (both quarterly financial reports and monthly revenue disclosure) from 1988 to 1993. We find that although both switches (from the semiannual reporting regime to the quarterly reporting regime and from the quarterly reporting regime to the monthly reporting regime) hasten the dissemination of the information contained in annual accruals into stock prices and reduce annual accrual mispricing, the switch to monthly reporting has a lesser effect. Our results are robust to controlling for risk factors, transaction costs, and potential changes in accrual, cash flow persistence, and sample composition over time. These results imply that more frequent reporting is one possible mechanism to reduce accrual mispricing. JEL Classifications: G14; L51; M41; M48. Data Availability: Data are available from sources identified in the paper.

Tax-Advantaged Trust Use Among IPO Executives: Determinants and Implications for Valuation and Future Performance

2019 ◽  
Vol 95 (3) ◽  
pp. 145-175 ◽  
Author(s):  
Michael J. Dambra ◽  
Matthew Gustafson ◽  
Phillip J. Quinn
Keyword(s):  
Stock Price ◽  
Relevant Information ◽  
Data Availability ◽  
Market Prices ◽  
The Public ◽  
Future Performance ◽  
Estate Taxes ◽  
Price Appreciation ◽  
One Year ◽  
Jel Classifications

ABSTRACT We examine the prevalence and determinants of CEOs' use of tax-advantaged trusts prior to their firm's IPO. Twenty-three percent of CEOs use tax-advantaged pre-IPO trusts, and share transfers into tax-advantaged trusts are positively associated with CEO equity wealth, estate taxes, and dynastic preferences. We project that pre-IPO trust use increases CEOs' dynastic wealth by approximately $830,000, on average. We next examine a simple model's prediction that trust use will be positively related to IPO-period stock price appreciation. We find that trust use is associated with 12 percent higher one-year post-IPO returns, but is not significantly related to the IPO's valuation, filing price revision, or underpricing. This evidence is consistent with CEOs' personal finance decisions prior to the IPO containing value-relevant information that is not immediately incorporated into market prices. JEL Classifications: D14; G12; G32; M21; M41. Data Availability: Data are available from the public sources cited in the text.

Concurrent Earnings Announcements and Analysts' Information Production

2019 ◽  
Vol 95 (1) ◽  
pp. 165-189 ◽  
Author(s):  
Matthew Driskill ◽  
Marcus P. Kirk ◽  
Jennifer Wu Tucker
Keyword(s):  
Earnings Announcements ◽  
Financial Analysts ◽  
Earnings Forecasts ◽  
Data Availability ◽  
Limited Attention ◽  
Conference Calls ◽  
Stock Recommendations ◽  
Rich Information ◽  
Sample Firm ◽  
Jel Classifications

ABSTRACT We examine whether financial analysts are subject to limited attention. We find that when analysts have another firm in their coverage portfolio announcing earnings on the same day as the sample firm (a “concurrent announcement”), they are less likely to issue timely earnings forecasts for the sample firm's subsequent quarter than analysts without a concurrent announcement. Among the analysts who issue timely earnings forecasts, the thoroughness of their work decreases as their number of concurrent announcements increases. In addition, analysts are more sluggish in providing stock recommendations and less likely to ask questions in earnings conference calls as their number of concurrent announcements increases. Moreover, when analysts face concurrent announcements, they tend to allocate their limited attention to firms that already have rich information environments, leaving behind firms in need of attention. Overall, our evidence suggests that even financial analysts, who serve as information specialists, are subject to limited attention. JEL Classifications: G10; G11; G17; G14. Data Availability: Data are publicly available from the sources identified in the paper.

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