Rounding Up Performance Measures in German Firms: Earnings Cosmetics or Earnings Management on a Larger Scale?

Journal of Business Finance and Accounting, forthcoming

39 Pages Posted: 10 Dec 2016 Last revised: 20 Aug 2020

See all articles by Sebastian Lebert

Sebastian Lebert

Ludwig Maximilian University of Munich

Ulf Mohrmann

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law

Ulrike Stefani

University of Konstanz - Department of Economics

Date Written: August 20, 2020

Abstract

We use Benford’s Law to provide evidence that German firms round up both their net income and earnings per share. We use the introduction of the euro to show that round earnings numbers are likely the result of earnings management. The incentive to round up comes from stakeholders’ left-digit bias when processing the information in financial statements. Since round numbers are natural benchmarks, stakeholders perceive the performance metrics directly below such thresholds as abnormally lower. However, rounding up is objectionable only if it involves large-scale earnings management, but not in cases of negligible “earnings cosmetics.” Because the difference between the pre-managed and reported earnings is unobservable, we investigate whether the prevalence of rounding up coincides with specific levels of several earnings characteristics and proxies for audit quality. If the rounding up is cosmetic, then it should occur independently of these characteristics. In contrast, if firms use earnings management on a larger scale, then it might not be possible to simultaneously round up and achieve other objectives of earnings management. Our evidence is in line with substantial earnings management.

Keywords: Benford’s Law, Cognitive Thresholds, Left-Digit Bias, Rounding Up Earnings Management, Earnings Characteristics, Audit Quality

JEL Classification: M41, M42, C46

Suggested Citation

Lebert, Sebastian and Mohrmann, Ulf and Stefani, Ulrike, Rounding Up Performance Measures in German Firms: Earnings Cosmetics or Earnings Management on a Larger Scale? (August 20, 2020). Journal of Business Finance and Accounting, forthcoming, Available at SSRN: https://ssrn.com/abstract=2882741 or http://dx.doi.org/10.2139/ssrn.2882741

Sebastian Lebert

Ludwig Maximilian University of Munich ( email )

Geschwister-Scholl-Platz 1
Munich, DE Bavaria 80539
Germany

Ulf Mohrmann (Contact Author)

Norwegian School of Economics (NHH) - Department of Accounting, Auditing and Law ( email )

Helleveien 30
N-5045 Bergen
Norway

Ulrike Stefani

University of Konstanz - Department of Economics ( email )

Konstanz, D-78457
Germany

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