Quarterly Earnings Management
Posted: 27 Nov 2018
Date Written: December 1, 2016
This paper examines the systematic difference between interim and fourth quarters in managerial decisions to engage in accruals and real activities management to meet analysts' quarterly earnings forecasts. Findings reveal that managers engage in income-increasing accounting accruals manipulations during the interim quarters. Managers engage in real activities management during the final quarter, through reductions in R&D and SG&A expenditures, aggressive sales discounts and overproduction of inventory. The managerial intervention with normal levels of R&D has become increasingly common following the implementation of the Sarbanes-Oxley Act (SOX) in 2003, and occurs throughout all four quarters. In the post-SOX period, firms also engage in aggressive sales discounts and overproduction before the year-end in order to boost earnings. There is an evident managerial preference in the timing between accruals and real activities management with the former being prevalent during the interim quarters when the discretion to delay expense recognition is allowed as part of integral accounting and the auditors scrutiny is absent, and the later only taking place mostly in the final quarter given the cost of adjusting operations towards meeting short term myopic targets. The business practice of reducing R&D and SG&A spending to gain short-term financial benefits is an unintended outcome that is partially attributed to the US accounting requirements of the direct expensing of firms' internal intangible investments. The myopic investment behaviour poses a barrier to the generation and development of firms' intellectual capital and may have detrimental effects on the long-term economic advances.
Keywords: accruals, earnings management, real activities
JEL Classification: M41, O32, M37
Suggested Citation: Suggested Citation