A Catering Theory of Earnings Management

58 Pages Posted: 5 Jun 2007 Last revised: 26 Oct 2007

See all articles by Shivaram Rajgopal

Shivaram Rajgopal

Columbia University - Columbia Business School, Accounting, Business Law & Taxation

Lakshmanan Shivakumar

London Business School

Ana Vidolovska Simpson

London School of Economics & Political Science - Department of Accounting

Date Written: October 24, 2007

Abstract

We propose that earnings management is driven by the prevailing investor demand for earnings surprises. Managers cater to investors by inflating earnings in periods when investors react optimistically to positive earnings surprises relative to negative earnings surprises and report more conservatively when investors react pessimistically to earnings news. Using aggregate market-level data, we find that the propensity to use income-increasing abnormal accruals is higher (lower) in quarters when proxies for investors' response to positive earnings surprises relative to negative earnings surprises is higher (lower). Further analysis suggests that investor sentiment might at least partly account for the relation between abnormal accruals and investors' earnings optimism.

Keywords: earnings management, sentiment, earnings optimism, aggregate-level earnings, abnormal accruals

JEL Classification: M41, M43, G12

Suggested Citation

Rajgopal, Shivaram and Shivakumar, Lakshmanan and Simpson, Ana, A Catering Theory of Earnings Management (October 24, 2007). Available at SSRN: https://ssrn.com/abstract=991138 or http://dx.doi.org/10.2139/ssrn.991138

Shivaram Rajgopal (Contact Author)

Columbia University - Columbia Business School, Accounting, Business Law & Taxation ( email )

3022 Broadway
New York, NY 10027
United States

Lakshmanan Shivakumar

London Business School ( email )

Regent's Park
London, NW1 4SA
United Kingdom
+44 20 7000 8115 (Phone)
+44 20 7000 8101 (Fax)

HOME PAGE: http://faculty.london.edu/lshivakumar/

Ana Simpson

London School of Economics & Political Science - Department of Accounting ( email )

United Kingdom

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