Economic Uncertainty and Earnings Management

49 Pages Posted: 11 Mar 2016 Last revised: 2 Oct 2016

See all articles by Luke C.D. Stein

Luke C.D. Stein

Arizona State University (ASU) - Finance Department

Charles C. Y. Wang

Harvard Business School

Date Written: August 23, 2016

Abstract

In the presence of managerial short-termism and asymmetric information about skill and effort provision, firms may opportunistically shift earnings from uncertain to more certain times. We document that firms report more negative discretionary accruals when financial markets are less certain about their future prospects. Stock-price responses to earnings surprises are moderated when firm-level uncertainty is high, consistent with performance being attributed more to luck rather than skill and effort, which can create incentives to shift earnings toward lower-uncertainty periods. We show that the resulting opportunistic earnings management is concentrated in CEOs, firms, and periods where such incentives are likely to be strongest: (1) where CEO wealth is sensitive to change in the share price, (2) where announced earnings are particularly likely to be an important source of information about managerial ability and effort, and (3) before implementation of Sarbanes-Oxley made opportunistic earnings management more challenging. Our evidence highlights a novel channel through which uncertainty affects managerial decision making in the presence of agency conflicts.

Keywords: Earnings management, discretionary accruals, uncertainty, implied volatility, earnings response coefficient

JEL Classification: G34, J33, M41, M52, G38

Suggested Citation

Stein, Luke C.D. and Wang, Charles C. Y., Economic Uncertainty and Earnings Management (August 23, 2016). Harvard Business School Accounting & Management Unit Working Paper No. 16-103; 2nd Annual Financial Institutions, Regulation and Corporate Governance Conference. Available at SSRN: https://ssrn.com/abstract=2746091 or http://dx.doi.org/10.2139/ssrn.2746091

Luke C.D. Stein

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States
480-965-9412 (Phone)
480-965-8539 (Fax)

HOME PAGE: http://www.lukestein.com

Charles C. Y. Wang (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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