On the Association between Voluntary Disclosure and Earnings Management
Posted: 17 Feb 1999
This paper investigates whether managers who issue annual earnings forecasts manage reported earnings towards their forecasts, fearing legal actions by investors and loss of reputation for accuracy. The empirical findings are consistent with the prediction that managers use positive discretionary accruals to manage reported earnings upward when earnings would otherwise be below management forecasts, and that the earnings management activity is increasing in expected litigation costs. Further analysis indicates that the positive discretionary accruals identified for firms whose managers have overestimated earnings do not seem to reflect the effect of competing earnings management incentives, nor the effect of a potential simultaneity between management's decisions to issue a forecast and manage reported earnings. Contrary to the findings for firms whose managers have overestimated earnings, I find no evidence that underestimated earnings are associated with income-decreasing discretionary accruals. However, managers who underestimate earnings are twice as likely to revise their forecasts as are managers who overestimate earnings, suggesting these managers favor forecast revision as a way to reduce their forecast errors.
JEL Classification: M41, M43, K22
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