Quadrophobia: Strategic Rounding of EPS Data

Abstract

Earnings management to round up reported EPS causes under-representation of the number four in the first post-decimal digit of EPS data, or "quadrophobia." We develop a simple measure of earnings management based on a firm's history of quadrophobia. Quadrophobia is pervasive and persistent, and predicts future restatements, SEC enforcement actions, and class action litigation. Quadrophobia, even if the result of proper accounting practices, thus appears correlated with a propensity to engage in other problematic accounting practices. The incidence of quadrophobia increases (declines) when firms gain (lose) analyst coverage and is more pronounced in pro forma earnings in a manner consistent with capital market pressure causing strategic rounding.

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

JEL Classification: G38, K22, M41