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Earnings Quality: Evidence from the Field

73 Pages Posted: 10 Jul 2012 Last revised: 21 Feb 2014

Ilia D. Dichev

Emory University - Department of Accounting

John R. Graham

Duke University; National Bureau of Economic Research (NBER)

Campbell R. Harvey

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER); Duke Innovation & Entrepreneurship Initiative

Shivaram Rajgopal

Columbia Business School

Multiple version iconThere are 2 versions of this paper

Date Written: May 7, 2013

Abstract

We provide insights into earnings quality from a survey of 169 CFOs of public companies and in-depth interviews of 12 CFOs and two standard setters. CFOs believe that (i) above all, high-quality earnings are sustainable and repeatable; specific characteristics include consistent reporting choices, backing by actual cash flows, and absence of one-time items and long-term estimates; (ii) about 50% of earnings quality is driven by non-discretionary factors such as industry and macro-economic conditions; (iii) in any given period, about 20% of firms manage earnings to misrepresent economic performance, and for such firms 10% of EPS is typically managed; (iv) earnings manipulation is hard to unravel from the outside but peer comparisons and lack of correspondence between earnings and cash flows provide helpful red flags. In addition, CFOs disagree with current standard setting on a number of issues including the sheer number of promulgated rules, the top-down approach to rule-making, the neglect of the matching principle, and the emphasis on fair value accounting. They indicate that a rules-based culture makes the audit function centralized and mechanical, and hinders the development of audit professionals. A summary impression from our work is that CFOs view earnings quality as more of a single and unconditional characteristic, in contrast to current research where measures of earnings quality are strongly conditional on the decision setting. This CFO view is related to their idea of “one number” - a single earnings metric that shapes both their interactions with external stakeholders and internal decision-making.

Presentation slides: Available at http://ssrn.com/abstract=2347428

Keywords: earnings quality, FASB, CFO, survey, earnings management

JEL Classification: M4, G38

Suggested Citation

Dichev, Ilia D. and Graham, John R. and Harvey, Campbell R. and Rajgopal, Shivaram, Earnings Quality: Evidence from the Field (May 7, 2013). Available at SSRN: https://ssrn.com/abstract=2103384 or http://dx.doi.org/10.2139/ssrn.2103384

Ilia D. Dichev

Emory University - Department of Accounting ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

John Robert Graham

Duke University ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7857 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Campbell R. Harvey

Duke University - Fuqua School of Business ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7768 (Phone)
919-660-8030 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Duke Innovation & Entrepreneurship Initiative ( email )

215 Morris St., Suite 300
Durham, NC 27701
United States

Shivaram Rajgopal (Contact Author)

Columbia Business School ( email )

3022 Broadway
New York, NY 10027
United States

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