Earnings Management at the Segment Level
45 Pages Posted: 24 May 2007 Last revised: 30 Jan 2009
Date Written: January 2009
We provide new empirical evidence on segment-level earnings management for a large sample of multi-segment firms by examining whether and how managers exploit their discretion in cost allocation to avoid reporting losses. We document that prior to SFAS 131 there is a significant discontinuity at zero (a "kink") in the frequency distribution of segment profits. After the implementation of SFAS 131, however, we do not observe a kink. Further, we find that the extent of cost under-allocation is significantly greater for the "small profit segments" than for the "small loss segments" only in the pre-SFAS 131 period; it is insignificantly different across the two groups in the post-SFAS 131 period. Taken together, our results are consistent with the pre-SFAS 131 kink being driven by opportunistic cost allocation, and the new segment reporting standard deterring earnings management in the form of cost under-allocation.
Keywords: Earnings management, segment profitability, discretionary disclosure, earnings distribution, cost allocation
JEL Classification: M4
Suggested Citation: Suggested Citation