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Abstract:
Using a unique database of monthly advertising spending in media outlets, we examine whether managers engage in real earnings management to meet quarterly financial reporting benchmarks. We extend prior literature by: (1) separately analyzing advertising activities, allowing us to explore novel issues such as the possibility that managers could either reduce or boost advertising to meet an earnings benchmark; (2) analyzing actual activities as opposed to inferring them from reported expenses, which are also subject to accrual choices; (3) investigating the timing, within a fiscal quarter, of altered advertising spending; and (4) examining quarterly as opposed to annual earnings benchmarks. Overall, we find that managers reduce their advertising spending to avoid losses and avoid earnings decreases. However, we also provide evidence that firms in the late stages of their life cycle choose to increase advertising to meet earnings benchmarks. Finally, we find some evidence that firms increase their advertising activities in the third month of a fiscal quarter and in the fourth quarter to meet or beat prior year’s earnings.

Real earnings management, advertising, earnings benchmarks

Abstract:
The cross-sectional approach that is typically used to estimate accrual models implicitly assumes that firms within the same industry have a homogeneous accrual generating process. In this paper, we examine this implicit assumption along three dimensions. First, we argue that the relation between working capital accruals and changes in sales is more complex than portrayed by existing empirical accrual models. In addition to sales changes, accruals are also affected by accrual determinants such as firms' inventory and credit policies. Second, we provide evidence that the assumption of a uniform accrual-generating process is violated in industries whose firms' accrual determinants are highly dispersed. Third, we document some implications of violating the assumption of a uniform accrual-generating process. Firms in industries with high variations in accrual determinants are likely to have large absolute abnormal accruals. We show that the previously-documented increase in the absolute level of abnormal accruals over time could be attributed, in part, to the increased heterogeneity in industries with respect to their accrual-generating processes.

accrual models, earning management

Abstract:
Using a unique database of monthly advertising spending in media outlets, we examine whether managers engage in real earnings management to meet quarterly financial reporting benchmarks. We extend prior literature by: (1) separately analyzing advertising activities, allowing us to explore novel issues such as the possibility that managers could either reduce or boost advertising to meet an earnings benchmark; (2) analyzing actual activities as opposed to inferring them from reported expenses, which are also subject to accrual choices; (3) investigating the timing, within a fiscal quarter, of altered advertising spending; and (4) examining quarterly as opposed to annual earnings benchmarks. Overall, we find that managers reduce their advertising spending to avoid losses and avoid earnings decreases. However, we also provide evidence that firms in the late stages of their life cycle choose to increase advertising to meet earnings benchmarks. Finally, we find some evidence that firms increase their advertising activities in the third month of a fiscal quarter and in the fourth quarter to meet or beat prior year’s earnings.