Earnings Management Proxies: Prudent Business Decisions or Earnings Manipulation?
57 Pages Posted: 13 Jun 2016 Last revised: 27 Aug 2018
Date Written: September 1, 2017
Earnings management proxies are frequently used to capture different “earnings management” constructs (e.g., earnings manipulation or beneficial earnings management). We present a simple framework that defines the specific construct of “earnings manipulation” and places it in context with the broader construct of “earnings management.” One distinguishing characteristic of earnings manipulation is that it should be negatively correlated with future operating performance when accruals reverse or the implications of real earnings management are realized. We examine the extent to which common earnings management proxies exhibit this expected relation to determine which measures are more likely to reflect earnings manipulation. Our results indicate substantial variation across earnings management proxies in this characteristic with some proxies consistently exhibiting a positive relation with future operating performance suggesting that these measures, on average, do not reflect earnings manipulation. Supplemental analyses that consider restatements, future returns, and financial reporting incentives yield similar inferences. Our results are important because if researchers interpret increases in these performance-enhancing empirical proxies as evidence of earnings manipulation, they are likely to reach inaccurate conclusions.
Keywords: discretionary accruals; real earnings management, earnings management, financial reporting quality, beneficial earnings management
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