Maintaining a Reputation for Consistently Beating Earnings Expectations and the Slippery Slope to Earnings Manipulation

58 Pages Posted: 19 May 2015 Last revised: 16 Jun 2018

Jenny Chu

University of Cambridge - Judge Business School

Patricia M. Dechow

University of Southern California - Leventhal School of Accounting; University of California, Berkeley - Accounting Group

Kai Wai Hui

The University of Hong Kong (HKU) - Department of Accounting

Annika Wang

University of Houston - Bauer College of Business

Date Written: June 6, 2018

Abstract

This paper investigates whether maintaining a reputation for consistently beating analysts’ earnings expectations can motivate executives to move from “within GAAP” earnings management to “outside of GAAP” earnings manipulation. We analyze firms subject to SEC enforcement actions and find that these firms consistently beat analysts’ quarterly earnings forecasts in the three years prior to the manipulation period and continue to do so by smaller “beats” during the manipulation period. We find that manipulating firms beat expectations around 86 percent of the time in the twelve quarters prior to the manipulation period (versus 75 percent for non-AAER firms) and that manipulation often ends with a miss in expectations. We document that executives of manipulating firms face strong stock market and CEO pressure to perform. Prior to the manipulation period, these firms have high analyst optimism, growing institutional interest, and high market valuations, along with powerful CEOs who exhibit evidence of overconfidence and have strong equity incentives. Overall, our results suggest that pressure to maintain a reputation for beating analysts’ expectations can encourage aggressive accounting and, ultimately, earnings manipulation.

Keywords: earnings manipulation; consecutively beating earnings expectations; market pressure; CEO overconfidence; CEO power; reputation; reference-dependent preferences; analysts’ forecasts and recommendation; institutional investors; overvaluation

JEL Classification: G12, M41

Suggested Citation

Chu, Jenny and Dechow, Patricia M. and Hui, Kai Wai and Wang, Annika, Maintaining a Reputation for Consistently Beating Earnings Expectations and the Slippery Slope to Earnings Manipulation (June 6, 2018). Available at SSRN: https://ssrn.com/abstract=2607219 or http://dx.doi.org/10.2139/ssrn.2607219

Jenny Chu

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

Patricia M. Dechow (Contact Author)

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

University of California, Berkeley - Accounting Group ( email )

Haas School of Business
Berkeley, CA 94720
United States

Kai Wai Hui

The University of Hong Kong (HKU) - Department of Accounting ( email )

Pokfulam Road
Hong Kong, Pokfulam
Hong Kong

Yu (Annika) Wang

University of Houston - Bauer College of Business

Bauer College of Business
4750 Calhoun Road
Houston, TX 77204
United States

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