The Information Quality Effect of Accruals-Based Benchmark Beating: Evidence from the CDS Market
50 Pages Posted: 28 Jul 2016 Last revised: 16 Apr 2018
Date Written: April 4, 2018
How does reaching financial reporting targets through earnings management interact with information quality? We address this question through flatness, a theoretically motivated measure of information quality based on the ratio of short-term to long term credit default swap spreads. We find that flatness increases when firms narrowly beat the analysts’ consensus earnings forecast through accruals management, indicative of information quality deterioration, but also that flatness is not sensitive to cash-flow-based real activities manipulation. Further, the main effect of accruals-based benchmark beating on flatness does not obtain for equity returns or for the level of CDS spreads, ruling out explanations related to valuation. Together, our findings imply that debt markets react to earnings management through an information quality channel and that accruals-based manipulation for benchmark beating diminishes the informativeness of the earnings signal for financial statement users.
Keywords: reporting benchmarks, accruals, information quality, credit default swaps
JEL Classification: D80, G10, M41
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