Evidence for the Existence of Downward Real Earnings Management
74 Pages Posted: 15 Mar 2012 Last revised: 15 Apr 2014
Date Written: April 13, 2014
Prior studies of real-activity earnings management (REM) focus on earnings-inflating abnormal activities. We seek to establish the existence of downward REM by investigating several corporate events in which managers have incentives to temporarily deflate market valuations. Specifically, we focus on, and find downward REM before, share repurchases, management buyouts (MBOs), and CEO option awards. Large-sample evidence of downward REM is also found in our general analysis of earnings smoothing. Downward REM becomes much smaller or nonexistent when there is a lack of managerial incentives in those events, such as non-carry-through repurchases, incomplete MBOs, and unexpected option awards. While firms' financial characteristics are shown to affect the magnitudes of downward REM, market participants, such as analysts, auditors, and institutional investors, do not seem to matter.
Keywords: downward earnings management, real earnings management, share repurchase, management buyout, CEO option grant, earnings smoothing
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