Quadrophobia: Strategic Rounding of EPS Data

Abstract

Managers' incentives to round up reported EPS cause under-representation of the number four in the first post-decimal digit of EPS, or "quadrophobia." We develop a novel measure of aggressive financial reporting practices based on a firm's history of quadrophobia. Quadrophobia is pervasive, persistent, and successfully predicts future restatements, SEC enforcement actions, and class action litigation. It is more pronounced when executive compensation is more closely tied to the stock price and when the firm anticipates violating debt covenants. Quadrophobia is especially strong when rounding-up EPS allows firms to meet analyst expectations, and investors seem not to see through this behavior.

Keywords: financial reporting practices, earnings management, earnings per share, forensic accounting, analyst coverage, accounting restatements, SEC enforcement actions, class action securities fraud litigation

JEL Classification: G24, G30, G38, K22, M41