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A Reputation for Beating Analysts' Expectations and the Slippery Slope to Earnings Manipulation

56 Pages Posted: 19 May 2015 Last revised: 26 Jun 2017

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 Yu Wang

University of Houston - Bauer College of Business

Date Written: June 23, 2017

Abstract

We investigate whether maintaining a reputation for consistently beating analysts’ earnings expectations motivates 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 are both more likely to consistently beat analysts’ quarterly earnings forecasts during the manipulation period as well as in the three years prior to the manipulation period. We examine whether manipulating firms appear to be under strong external market pressure to meet expectations. Consistent with market pressure playing a role, we find that manipulating firms have high long-term growth expectations, growing institutional investment, high market values relative to fundamentals, and are strongly recommended by analysts. We also investigate whether pressure from within the organization influences the likelihood of manipulation. We find that while CEO power plays a role, the evidence on CEO overconfidence is weak. Overall, our results suggest that maintaining a reputation for meeting 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 Yu, A Reputation for Beating Analysts' Expectations and the Slippery Slope to Earnings Manipulation (June 23, 2017). 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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