Evidence for the Existence of Downward Real Earnings Management

74 Pages Posted: 15 Mar 2012 Last revised: 15 Apr 2014

See all articles by Bill B. Francis

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management

Iftekhar Hasan

Fordham University - Gabelli School of Business; Bank of Finland

Lingxiang Li

Rensselaer Polytechnic Institute (RPI) - Lally School of Management

Date Written: April 13, 2014

Abstract

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

Suggested Citation

Francis, Bill B. and Hasan, Iftekhar and Li, Lingxiang, Evidence for the Existence of Downward Real Earnings Management (April 13, 2014). Available at SSRN: https://ssrn.com/abstract=2022639 or http://dx.doi.org/10.2139/ssrn.2022639

Bill B. Francis

Rensselaer Polytechnic Institute (RPI) - Lally School of Management ( email )

Troy, NY 12180
United States

Iftekhar Hasan (Contact Author)

Fordham University - Gabelli School of Business ( email )

Rose Hill Campus Bronx
New York, NY 10458
United States

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Lingxiang Li

Rensselaer Polytechnic Institute (RPI) - Lally School of Management ( email )

Troy, NY 12180
United States

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