Earnings Management Proxies: Prudent Business Decisions or Earnings Manipulation?
Theodore E. Christensen
University of Georgia
Adrienna A. Huffman
Tulane University - A.B. Freeman School of Business
Melissa Fay Lewis-Western
Brigham Young University
December 25, 2016
We assess the extent to which commonly used earnings management proxies actually capture earnings manipulation. We argue that current-period earnings manipulation should lead to declining future operating performance when accruals reverse or the implications of real earnings management are realized. Although many studies use this logic, prior research does not provide a systematic investigation of these relations. We find that three earnings management measures are negatively associated with firms’ future operating performance (earnings and cash flows), indicating that they likely reflect the construct of earnings manipulation. However, we find that four common earnings management proxies are actually positively associated with firms’ future operating performance. Thus, these four frequently-used measures do not appear to reflect earnings manipulation, but instead may capture prudent business decisions or non-opportunistic earnings management. In supplemental analyses, we also examine stock price performance and restatements. Moreover, we consider managers’ reporting incentives. Inferences from these analyses suggest that our main inferences are very robust.
Number of Pages in PDF File: 53
Keywords: discretionary accruals; real earnings management, earnings management, financial reporting quality, beneficial earnings management
Date posted: June 13, 2016 ; Last revised: January 27, 2017