Real Earnings Management by Benchmark-Beating Firms: Implications for Future Profitability

54 Pages Posted: 24 Jul 2018

See all articles by Brooke Beyer

Brooke Beyer

Kansas State University

Sandeep Nabar

Oklahoma State University, Stillwater - Spears School of Business

Eric T. Rapley

Colorado State University, Fort Collins - Department of Accounting

Date Written: May 15, 2018

Abstract

Prior studies document both an improvement and deterioration in the future operating performance of firms engaging in real earnings management (REM) to meet earnings benchmarks. These results suggest that some firms use REM to signal their favorable prospects, whereas others use REM opportunistically. We hypothesize that firms with less robust information environments, more costly REM, and fewer incentives to meet short-term earnings benchmarks are more likely to engage in REM to signal future performance. Consistent with expectations, we find the positive relation between REM and future profitability is limited to firms that have less robust information environments (measured with stock return volatility, bid/ask spread, and analysts following), more costly REM (measured with market share and financial health), and fewer incentives to meet short-term earnings benchmarks (measured with market-to-book ratio, transient investors, and seasoned equity offering). In supplementary analysis, we note that Bhojraj et al. (2009) restrict their sample to relatively large firms, whereas Gunny’s (2010) sample includes both large and small firms. Our analysis indicates that the difference in sample composition explains the differing results. We find that small firms use REM to signal positive future performance, but large firms do not.

Keywords: real earnings management, future operating performance, signaling, opportunistic behavior

JEL Classification: M40, M41

Suggested Citation

Beyer, Brooke and Nabar, Sandeep and Rapley, Eric T., Real Earnings Management by Benchmark-Beating Firms: Implications for Future Profitability (May 15, 2018). Accounting Horizons, Forthcoming. Available at SSRN: https://ssrn.com/abstract=3206979

Brooke Beyer

Kansas State University ( email )

Manhattan, KS 66506
United States
7855325916 (Phone)

Sandeep Nabar

Oklahoma State University, Stillwater - Spears School of Business ( email )

456 Spears School of Business
Stillwater, OK 74078-1680
United States

Eric T. Rapley (Contact Author)

Colorado State University, Fort Collins - Department of Accounting ( email )

257 Rockwell Hall
Fort Collins, CO 80523
United States
970.491.7481 (Phone)

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