Cross-Firm Real Earnings Management

Abstract

Our analysis is rooted in the notion that stockholders can learn about the fundamental value of any particular firm from observing the earnings reports of its rivals. We argue that such intra-industry information transfers, which have been broadly documented in the empirical literature, may motivate managers to alter stockholders’ beliefs about the value of their firm not only by manipulating their own earnings report but also by influencing the earnings reports of rival firms. Managers obviously do not have access to the accounting system of peer firms, but they can nevertheless influence the earnings reports of rival firms by distorting real transactions that relate to the product market competition. We demonstrate such managerial behavior, which we refer to as cross-firm real earnings management, and explore its potential consequences and its interrelation with the practice of accounting-based earnings management within an industry setting with imperfect (non-proprietary) accounting information.