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Author: Somnath Das
Publisher:
ISBN:
Category :
Languages : en
Pages : 51
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Book Description
This paper investigates whether the pattern of quarterly earnings changes provides a signal of earnings management. We identify firms for which the sign of (seasonal) earnings changes observed in interim quarters reverses in the fourth quarter. We hypothesize that a firm performing poorly in interim quarters may attempt to increase earnings of the fourth quarter to achieve a desired annual earnings target, while a firm performing well in interim quarters may attempt to decrease earnings of the fourth quarter to build reserves for the future. Our results show that reversal of earnings changes in the fourth quarter is a common phenomenon and its occurrence is greater than would be expected by chance. Other indicators of earnings management, such as the size and direction of discretionary accruals, reversals in subsequent accruals, the use of special items in the income statement, and adjustment of Ramp;D spending, suggest that firms with earnings reversals are more likely to have managed earnings than industry and performance matched control firms. The capital market appears to attach lower credibility to earnings reported by the reversal samples. Our collective evidence leads us to suspect that fourth-quarter reversals on average reflect earnings management behavior. We recommend that analysts use earnings reversals as a heuristic to detect potential cases of earnings management in conjunction with other indicators, such as the magnitude of discretionary accruals. We further find that firms in the reversal samples significantly overlap with the sample of firms reporting small profits and small EPS increases. These results provide an interesting insight - that at least one-fourth of the sample of firms that meet or just beat earnings targets are attempting to smooth annual earnings by managing earnings downward in the fourth quarter.
Author: Somnath Das
Publisher:
ISBN:
Category :
Languages : en
Pages : 51
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Book Description
This paper investigates whether the pattern of quarterly earnings changes provides a signal of earnings management. We identify firms for which the sign of (seasonal) earnings changes observed in interim quarters reverses in the fourth quarter. We hypothesize that a firm performing poorly in interim quarters may attempt to increase earnings of the fourth quarter to achieve a desired annual earnings target, while a firm performing well in interim quarters may attempt to decrease earnings of the fourth quarter to build reserves for the future. Our results show that reversal of earnings changes in the fourth quarter is a common phenomenon and its occurrence is greater than would be expected by chance. Other indicators of earnings management, such as the size and direction of discretionary accruals, reversals in subsequent accruals, the use of special items in the income statement, and adjustment of Ramp;D spending, suggest that firms with earnings reversals are more likely to have managed earnings than industry and performance matched control firms. The capital market appears to attach lower credibility to earnings reported by the reversal samples. Our collective evidence leads us to suspect that fourth-quarter reversals on average reflect earnings management behavior. We recommend that analysts use earnings reversals as a heuristic to detect potential cases of earnings management in conjunction with other indicators, such as the magnitude of discretionary accruals. We further find that firms in the reversal samples significantly overlap with the sample of firms reporting small profits and small EPS increases. These results provide an interesting insight - that at least one-fourth of the sample of firms that meet or just beat earnings targets are attempting to smooth annual earnings by managing earnings downward in the fourth quarter.
Author: John M. Carlson
Publisher:
ISBN:
Category :
Languages : en
Pages : 102
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Book Description
This study asks a very specific question: Does the market see through seasonal quarterly earnings patterns? The idea is motivated by the evidence presented in Das, Shroff, Zhang (2009) paper which investigated seasonal quarterly earnings patterns and found firms that had fourth quarter reversal patterns, as compared to matched controlled firms, had traits or characteristics that were similar to firms that were earmarked for earnings management using earlier testing procedures such as accruals testing (size, direction, and discretionary), special items and real earnings management. Pervasive existence of fourth quarter reversal phenomenon is not necessarily a priori evidence that the market does not see through the phenomenon. Even if the market can see through the seasonal differencing pattern, management may use this as a tool to convey additional information. Income smoothing has been argued as a way to signal "good news" and as a way to dampen fluctuations around a perceived normal earnings number (Beidleman 1973; Graham et al. 2005). On the other hand, firms may want to fool the market in order to maintain an existing stock price, earn personal incentives for management, or minimize third-party interference (Schipper 1989; Healy and Wahlen 1999). Therefore, the market's possible inability to notice and react to the reversal pattern would be consistent with the conventional wisdom of the earnings management literature. Using an amended Easton and Harris (1991) model, I study whether the earnings variables are more informative based upon the seasonal differencing patterns by incorporating dummy variables, along with their respective interaction terms, to signify the first time the pattern occurs and a second set of dummies if the pattern repeats or reverses. My results show the market sees the seasonal quarterly earnings pattern; in fact it identifies the pattern in advance via the alternative year-ends. The earning levels and changes in earnings variables are more informative but the earnings tend to are transitory, not permanent in nature. All other tests performed support these general conclusions.
Author: Somnath Das
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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Book Description
This paper investigates potential cases of earnings management by observing the pattern of quarterly earnings changes. We identify firms for which the sign of (seasonal) earnings changes observed in interim quarters reverses in the fourth quarter. We hypothesize that a firm performing poorly in interim quarters may attempt to increase earnings of the fourth quarter to achieve a desired annual earnings target, while a firm performing well in interim quarters may attempt to decrease earnings of the fourth quarter to build "reserves" for the future. Our results show that reversal of earnings changes in the fourth quarter is a common phenomenon and its occurrence is greater than would be expected by chance. Other indicators of earnings management, such as the size and direction of changes in fourth quarter accruals, reversals in subsequent earnings performance, and the use of special items in the income statement, suggest that firms with earnings reversals are more likely to have managed earnings than a control sample of nonreversal firms. Our results also indicate that the reversal firms may have debt-contracting and political costs-related incentives to manage earnings and a significant percentage of them may manage earnings to avoid reporting a decrease in annual earnings. Capital market participants and financial analysts both appear to attach lower credibility to earnings reported by the reversal samples. Our collective evidence leads us to suspect that fourth quarter reversals reflect earnings management behavior rather than some other phenomena, such as mean reversion of earnings or fourth quarter settling up.
Author: Malek El Diri
Publisher: Springer
ISBN: 3319626868
Category : Business & Economics
Languages : en
Pages : 120
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Book Description
This book provides researchers and scholars with a comprehensive and up-to-date analysis of earnings management theory and literature. While it raises new questions for future research, the book can be also helpful to other parties who rely on financial reporting in making decisions like regulators, policy makers, shareholders, investors, and gatekeepers e.g., auditors and analysts. The book summarizes the existing literature and provides insight into new areas of research such as the differences between earnings management, fraud, earnings quality, impression management, and expectation management; the trade-off between earnings management activities; the special measures of earnings management; and the classification of earnings management motives based on a comprehensive theoretical framework.
Author: Zhaoyang Gu
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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Book Description
Earnings management is a key issue for financial reporting. The purpose of this paper is to derive a set of indices to measure the pervasiveness of earnings management (PEM) using the properties of quarterly accrual volatility. The PEM index can be viewed as a quality measure of financial reporting and an effectiveness measure for financial monitoring. In contrast to mean-shifting studies in the literature, our measure based on accrual volatility yields two major advantages. First, it relieves us of the necessity of precise assumptions regarding economic events. Second, it provides a macro-perspective on the overall patterns in earnings management. The methodology based on accrual volatility can address issues like the earnings quality, the nature of the informational environment, and the effect of accounting standard setting. The seasonal pattern of accrual volatility can provide a trace of earnings management, even in the absence of further information about specific economic events and resulting managerial actions. Our working hypothesis is that pervasive earnings management leads to the first order stochastic dominance of fourth quarter accrual volatility over the other three quarters. We provide evidence on the relations between previously documented drivers of earnings management and seasonal accrual heteroskedasticity. These drivers include executive compensation, regulatory requirements, bond covenants, and political costs. This empirical support of our working hypothesis validates our application of Kolmogorov-Smirnov (KS) Distance to measure the pervasiveness of earnings management (PEM). We use raw total accruals as the basis for measuring PEM1 and use residuals from Jones? [1991] model to control for mechanical factors in our measurement of PEM2. The usefulness of controls is an empirical issue. Our results suggest that additional controls do not add much power to detect earnings management over and above the simplest measure based on total accruals. KS Distance is powerful in detecting the difference around the central locations of two distributions, but not powerful at the tail ends. We develop two other measures for PEM. First, we estimate the fraction of fourth quarter accruals volatility exceeding the 95th percentile value for the first three quarters (base period) distribution. This fraction, reduced by 5%, constitutes PEM3. Second, we design a simulation method to determine PEM4 as the percentage of firms with a given magnitude of accrual adjustment for the base period accrual volatility to match that of the fourth quarter. Both PEM3 and PEM4 are estimates of percentage of firms involved in earnings management of a given magnitude. However, we should note here that our PEM indices are more likely ordinal than cardinal measures. Though our methods of measuring PEM rely on indirect measurement, we provide direct evidence on the relevance of our method through a series of external validation checks. First, we use a subsample of firms subject to SEC actions relating to alleged earnings manipulation. This data was collected from Accounting and Auditing Enforcement Releases (AAER's) by the SEC. We compare PEM?s for the AAER sample to PEM?s for the COMPUSTAT sample to assess the power of our measures. The PEM indices for the AAER sample are two to three times as large as the PEM indices for the COMPUSTAT sample. Though we avoid interpreting the relative magnitudes literally, these differences do suggest a positive correlation between our PEM indices and the degree of earnings management. Second, we conduct case studies for 10 firms identified by fourth quarter accrual volatility as strongly suspect of earnings management. These studies show that suspect firms frequently engage in activities associated with earnings management, such as CEO turnover, restructuring, public offerings, or they experience losses. Applying our PEM indices to COMPUSTAT data, we find that pervasiveness of earnings management has been relatively stable in the period of 1988-1996.
Author: Meng Yan
Publisher:
ISBN:
Category : Corporations
Languages : en
Pages : 348
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Book Description
Author: Demetris Christodoulou
Publisher:
ISBN:
Category :
Languages : en
Pages :
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Book Description
This paper examines the systematic difference between interim and fourth quarters in managerial decisions to engage in accruals and real activities management to meet analysts' quarterly earnings forecasts. Findings reveal that managers engage in income-increasing accounting accruals manipulations during the interim quarters. Managers engage in real activities management during the final quarter, through reductions in R&D and SG&A expenditures, aggressive sales discounts and overproduction of inventory. The managerial intervention with normal levels of R&D has become increasingly common following the implementation of the Sarbanes-Oxley Act (SOX) in 2003, and occurs throughout all four quarters. In the post-SOX period, firms also engage in aggressive sales discounts and overproduction before the year-end in order to boost earnings. There is an evident managerial preference in the timing between accruals and real activities management with the former being prevalent during the interim quarters when the discretion to delay expense recognition is allowed as part of integral accounting and the auditors scrutiny is absent, and the later only taking place mostly in the final quarter given the cost of adjusting operations towards meeting short term myopic targets. The business practice of reducing R&D and SG&A spending to gain short-term financial benefits is an unintended outcome that is partially attributed to the US accounting requirements of the direct expensing of firms' internal intangible investments. The myopic investment behaviour poses a barrier to the generation and development of firms' intellectual capital and may have detrimental effects on the long-term economic advances.
Author: John Jacob
Publisher:
ISBN:
Category :
Languages : en
Pages : 69
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Book Description
Quarterly earnings allow aggregation into annual earnings in four different ways. Fiscal year reported earnings is one of these four possible measures of annual earnings, the others being earnings for years ending at the first, second and third fiscal quarters. We provide evidence on earnings management in fiscal year earnings relative to these three alternative measures of firms' annual earnings. We confirm prior findings in Burgstahler and Dichev (1997) of discontinuities around zero and around prior year earnings in histograms of fiscal year earnings. Subsequent research questions whether these discontinuities are evidence of earnings management or whether they are attributable to biases induced by taxes, scaling and sample selection. Using the histograms of our alternative annual earnings measures, we offer additional evidence in this debate. We also find evidence of earnings management in broader intervals around thresholds. We believe that our research design is better suited to test for earnings management in these broader intervals than those used in prior studies. We also compare the statistical properties of fiscal year earnings to annual earnings starting with the fiscal year quarters two, three and four. We find that the variance and kurtosis of earnings are higher for fiscal year earnings while skewness of earnings is lower at the fiscal year. These results are more consistent with earnings management than with the effects induced by 'settling up' in fourth quarter earnings. Overall, this study contributes to the literature on the prevalence, effects of and factors associated with earnings management.
Author: Joshua Ronen
Publisher: Springer Science & Business Media
ISBN: 0387257713
Category : Business & Economics
Languages : en
Pages : 587
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Book Description
This book is a study of earnings management, aimed at scholars and professionals in accounting, finance, economics, and law. The authors address research questions including: Why are earnings so important that firms feel compelled to manipulate them? What set of circumstances will induce earnings management? How will the interaction among management, boards of directors, investors, employees, suppliers, customers and regulators affect earnings management? How to design empirical research addressing earnings management? What are the limitations and strengths of current empirical models?
Author: Katherine Gunny
Publisher:
ISBN:
Category :
Languages : en
Pages : 0
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Book Description
We compare earnings for the last twelve months ending in quarter four (i.e., fiscal year earnings), three, two and one. Prior literature offers two competing explanations for why fourth quarter earnings exhibit higher volatility than other interim quarters. Under the first explanation, GAAP assumes that quarterly earnings are an integral part of annual earnings and are used to settle up annual earnings. Any estimation errors in the preceding three quarters are corrected through fourth quarter earnings, which could make them more volatile. Under the second explanation, compensation and lending contracts based on fiscal year earnings lead to a concentration of earnings management in the fourth quarter and thus more volatile fourth quarter earnings. Although both explanations have similar predictions for the properties of quarterly earnings, our simulations show that these explanations, as suggested by Lipe and Bernard 2000, have distinct implications for the properties of annual earnings ending in quarter four, three, two and one. Overall, our results are more consistent with earnings management than settling up. In addition, we examine the relative earnings attributes and find that fiscal year earnings attributes rank lower on dimensions of accrual quality, persistence, predictability, and smoothness. Finally, we re-investigate the accrual anomaly and find that the accrual anomaly is more pronounced for fiscal year earnings.
