Target Shooting: Review of Earnings Management Around Earnings Benchmarks

Abstract

In this paper we review the literature dealing with earnings management around earnings benchmarks. The earnings benchmarks are the earnings level (loss avoidance), earnings improvement (earnings changes), and the analyst forecast benchmark. Healy and Wahlen [1999] review the implications of earnings management studies for standard setters. With a standard setter framework and a focus on earnings benchmarks as the motive for earnings management, we document the direction of earning management studies since Healy and Wahlen [1999]. Studies have (1) found that firms' management have market incentives and also compensation incentives to meet or beat the three earnings benchmarks, (2) questioned the cross-sectional distribution evidence of the frequency of earnings management around the earnings benchmarks, (3) documented methods firms' management use to manage earnings to beat these benchmarks, and (4) tested whether the market sees through firms that manage earnings to beat benchmarks. We discuss research that identifies factors that constrain earnings management to beat benchmarks and research that has attempted to determine which benchmark is the most important to firms' management. We also discuss areas of interest to standard setters that have not been addressed by current accounting literature and present avenues for future research.

Keywords: earnings management, earnings distributions, earnings benchmarks

JEL Classification: M41, M43, M44, J33, G12, G14