Earnings Management, Chapter 11 Emergence and Firm Value
34 Pages Posted: 31 May 2016 Last revised: 21 Jun 2017
Date Written: May 30, 2016
We study the impact of earnings management prior to bankruptcy filing on the passage of firms through Chapter 11. Using data on 261 U.S. public firms, we construct three measures of earnings management, two of which are accounting (accrual) manipulation measures (discretionary accruals and abnormal working capital accruals) and one a real activities manipulation measure (abnormal operating cash flows). Our key findings are that earnings management prior to bankruptcy significantly reduces the likelihood of Chapter 11 plan confirmation and emergence from Chapter 11. The results are driven primarily by extreme values of earnings management, characterized by one or two standard deviations above or below the (zero) mean. The findings are consistent with creditors reacting positively to unduly conservative earnings reports and negatively to overly optimistic earnings reports. We find clear evidence that upward management of earnings destroys economic value by making the survival of the firm less likely, an effect that has not previously been uncovered by the literature. We also find that stressed firms are less likely to have their plans confirmed while the auditor choice (Big4 vs. non-Big4) positively affects the probability for plan confirmation as well as the likelihood of emergence from bankruptcy.
Keywords: Bankruptcy, Chapter 11, Financial reorganization, Earnings management, Auditor choice
JEL Classification: G33, M41
Suggested Citation: Suggested Citation