The Effects of Real Earnings Management on the Firm, its Competitors and Subsequent Reporting Periods

Abstract:     
Prior research hypothesizes managers strategically time retail price promotions to manage reported earnings. However, the reaction of competitors to such real earnings management behavior is less well studied.

Consistent with the prior research, I show evidence that firms use fiscal quarter-end price promotions to accelerate sales inter-temporally in order to meet earnings targets they would otherwise have missed. By analyzing the combination of price promotions and earnings management incentives across the fiscal year, I demonstrate that firms respond more aggressively to the earnings management incentives of their competitors than to their pricing. I further show that price discounts related to earnings management incentives persist in subsequent reporting periods.

These results highlight the complexity of corporate behavior in a real earnings management setting and the need to adequately control for competitor response in related research. Furthermore, they imply that firms with earnings management incentives encourage competitive responses, regardless of whether they actually reduce prices themselves. Subsequent text analysis of earnings related conference calls shows frequent examples of statements consistent with firms attempting to signal stable pricing commitments, possibly to discourage this type of competitive response.

Number of Pages in PDF File: 56

Keywords: Accounting, Marketing, Promotions, Real Earnings Management, Competition

JEL Classification: M31, M41

working papers series