48 Pages Posted: 24 Apr 2000
Date Written: April 10, 2000
Prior research has documented the empirical regularity that more firms than expected (i) report small positive earnings and (ii) have zero forecast errors. It appears that management avoid reporting negative earnings or disappointing analysts. We investigate how and why firms beat these benchmarks (benchmark beaters).
We document that benchmark beaters have high accruals and unusual levels of special items relative to other firms. We find that a strong motivation for reporting small profits is to delay reporting bad news. We find that small profit firms show a decline in earnings and exhibit poor stock price performance over the following year. In contrast, we find that firms with zero forecast errors do well in the future. These firms have positive abnormal returns over the following year. We document that zero forecast error firms are high growth, high market capitalization firms. We argue that these firms want to avoid disappointing analysts since they are most likely to suffer from the "torpedo effect": small earnings disappointments lead to large stock price declines.
Keywords: Earnings management, accruals, benchmark
JEL Classification: M41, M43, G29
Suggested Citation: Suggested Citation
Dechow, Patricia M. and Richardson, Scott A. and Tuna, A. Irem, Are Benchmark Beaters Doing Anything Wrong? (April 10, 2000). Available at SSRN: https://ssrn.com/abstract=222552 or http://dx.doi.org/10.2139/ssrn.222552