Industry Valuation Driven Earnings Management
Erasmus University Rotterdam (EUR) - Financial Management
Rotterdam School of Management, Erasmus University; Erasmus Research Institute of Management (ERIM)
Erasmus University Rotterdam (EUR) - Department of Financial Management
October 25, 2007
ERIM Report Series Reference No. ERS-2007-069-F&A
This paper investigates whether industry valuation impacts firms’ earnings management decisions. Existing accounting literature assumes that industry valuation has a constant impact on this decision. We argue that a higher industry valuation increases the perceived benefits of earnings management at a time when the negative consequences associated with accrual reversal and the probability of detection are believed to be lower. Using a sample of quarterly data of U.S. firms from 1985 to 2005, we find that the four-quarter lagged industry valuation has a positive relationship with industry aggregate (current) discretionary accruals. More specific, one standard deviation increase in the aggregate industry valuation is associated with a significant increase of 2.4 cents in quarterly earnings per share. Our results are robust after controlling for several factors, including bubble years, size, leverage and performance.
Number of Pages in PDF File: 44
Keywords: Industry valuation, Earnings management, Market to book ratio
Date posted: November 27, 2007
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