Do Firms Manage Earnings to Meet Dividend Thresholds?
Naveen D. Daniel
Drexel University - Department of Finance
David J. Denis
University of Pittsburgh
AFA 2008 New Orleans Meetings Paper
We find that firms are more likely to manage earnings upward when their earnings would otherwise fall short of expected dividend levels. This earnings management behavior appears to significantly impact the likelihood of a dividend cut. Firms whose discretionary accruals cause reported earnings to exceed expected dividend levels are significantly less likely to cut dividends than are firms whose reported earnings fall short of expected dividend levels. These findings are robust to controls for other determinants of discretionary accruals and other determinants of the likelihood of a dividend cut. Finally, we report that, in response to an earnings shortfall, earnings management is more aggressive prior to the passing of the Sarbanes-Oxley Act, subsequent to the 2003 dividend tax cut, in firms with high payout ratios, in firms whose CEOs receive higher dollar dividends, in firms whose CEOs have higher pay-performance sensitivities, and in firms that raise less outside equity. Collectively, these findings imply that managers treat expected dividend levels as an important earnings threshold.
Number of Pages in PDF File: 57
Keywords: dividend policy, dividend smoothing, earnings management, accruals
JEL Classification: M41, M43, G35, G38working papers series
Date posted: March 11, 2007
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