Earnings Management Proxies: Prudent Business Decisions or Earnings Manipulation?

53 Pages Posted: 13 Jun 2016 Last revised: 27 Jan 2017

Theodore E. Christensen

University of Georgia

Adrienna A. Huffman

Tulane University - A.B. Freeman School of Business

Melissa Fay Lewis-Western

Brigham Young University

Date Written: December 25, 2016

Abstract

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.

Keywords: discretionary accruals; real earnings management, earnings management, financial reporting quality, beneficial earnings management

Suggested Citation

Christensen, Theodore E. and Huffman, Adrienna A. and Lewis-Western, Melissa Fay, Earnings Management Proxies: Prudent Business Decisions or Earnings Manipulation? (December 25, 2016). Available at SSRN: https://ssrn.com/abstract=2793838

Theodore E. Christensen

University of Georgia ( email )

Athens, GA
United States

Adrienna A. Huffman (Contact Author)

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Melissa Fay Lewis-Western

Brigham Young University ( email )

Provo, UT 84602
United States
801-703-8426 (Phone)

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