Do Shareholders Assess Managers’ Use of Accruals to Manage Earnings as a Negative Signal of Trustworthiness Even When its Outcome Serves Shareholders’ Interests?
54 Pages Posted: 6 Apr 2013 Last revised: 27 Feb 2019
Date Written: February 23, 2019
Using a controlled experiment, we examine how shareholders’ trust in managers is influenced by the interaction of (1) the outcome of earnings management (i.e., inconsistent or consistent with shareholders’ interests), and (2) the method of earnings management (i.e., accruals or real methods). We predict and find that the method of earnings management only affects trust—and ultimately investment decisions—when the outcome of earnings management is consistent with shareholders’ interests. In this situation, we predict that managers’ use of accruals—relative to real methods—to manage earnings is more likely to impair trust because it involves dishonest reporting. Our findings are consistent with this explanation and are opposite to the effect of the method of earnings management on cash flows in our setting. Conversely, we find that trust and cash flows are both adversely affected when the outcome of earnings management is inconsistent with shareholders’ interests. Our study contributes to the literature by highlighting when the method of earnings management provides shareholders with a distinct signal concerning managers’ trustworthiness.
Keywords: earnings management; accruals vs. real methods; trust; investment decisions
JEL Classification: M41, M52
Suggested Citation: Suggested Citation