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
Date Written: June 6, 2018
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: Suggested Citation