Industry Valuation Driven Earnings Management

44 Pages Posted: 27 Nov 2007  

Tao Jiao

Erasmus University Rotterdam (EUR) - Financial Management

Peter Roosenboom

Rotterdam School of Management, Erasmus University; Erasmus Research Institute of Management (ERIM)

Gerard Mertens

Erasmus University Rotterdam (EUR) - Department of Financial Management

Date Written: October 25, 2007

Abstract

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.

Keywords: Industry valuation, Earnings management, Market to book ratio

Suggested Citation

Jiao, Tao and Roosenboom, Peter and Mertens, Gerard, Industry Valuation Driven Earnings Management (October 25, 2007). ERIM Report Series Reference No. ERS-2007-069-F&A. Available at SSRN: https://ssrn.com/abstract=1032748

Tao Jiao (Contact Author)

Erasmus University Rotterdam (EUR) - Financial Management ( email )

United States

Peter Roosenboom

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T09-56
3000 DR Rotterdam
Netherlands
+31 10 40 82255 (Phone)

Erasmus Research Institute of Management (ERIM) ( email )

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Gerard Mertens

Erasmus University Rotterdam (EUR) - Department of Financial Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2556 (Phone)
+31 10 408 9017 (Fax)

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