Performance Shocks and Misreporting

Journal of Accounting and Economics, Forthcoming

Chicago Booth Research Paper No. 10-12

36 Pages Posted: 3 Feb 2010 Last revised: 3 Apr 2013

See all articles by Joseph Gerakos

Joseph Gerakos

Tuck School of Business at Dartmouth College

Andrei Kovrijnykh

Arizona State University (ASU)

Date Written: February 1, 2013

Abstract

We propose a parsimonious stochastic model of reported earnings that links misreporting to performance shocks. Our main analytical prediction is that misreporting leads to a negative second-order autocorrelation in the residuals from a regression of current earnings on lagged earnings. We also propose a stylized dynamic model of earnings manipulation and demonstrate that both earnings smoothing and target-beating considerations result in the same predictions of negative second-order autocorrelations. Empirically, we find that the distribution of this measure is asymmetric around zero with 27 percent of the firms having significantly negative estimates. Using this measure, we specify a methodology to estimate the intensity of misreporting and to create estimates of unmanipulated earnings. Our estimates of unmanipulated earnings are more correlated with contemporaneous returns and have higher volatility than reported earnings. With respect to economic magnitude, we find that, in absolute terms, median misreporting is 0.7 percent of total assets. Moreover, firms in our sample subject to SEC AAERs have significantly higher estimates of manipulation intensity.

Suggested Citation

Gerakos, Joseph and Kovrijnykh, Andrei, Performance Shocks and Misreporting (February 1, 2013). Journal of Accounting and Economics, Forthcoming, Chicago Booth Research Paper No. 10-12, Available at SSRN: https://ssrn.com/abstract=1546478 or http://dx.doi.org/10.2139/ssrn.1546478

Joseph Gerakos (Contact Author)

Tuck School of Business at Dartmouth College ( email )

Hanover, NH 03755
United States

Andrei Kovrijnykh

Arizona State University (ASU) ( email )

Farmer Building 440G PO Box 872011
Tempe, AZ 85287
United States
480-965-6216 (Phone)

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