Changes in Accounting Estimates: Managerial Opportunism or Risky Firms?
Baruch College Zicklin School of Business Research Paper No. 2019-02-01
55 Pages Posted: 29 Jan 2019 Last revised: 3 Dec 2019
Date Written: November 11, 2019
We investigate whether companies strategically change accounting estimates to manipulate earnings, as some claim (“opportunism” hypothesis), or whether these modifications represent changes in the underlying fundamentals of financially troubled or risky companies updating their priors about future expectations because of operational changes (“risk” hypothesis). Using audit fees, propensity to meet or beat earnings forecasts, and restatements as surrogates for managerial opportunism/bias, we find evidence consistent with the risk hypothesis and inconsistent with opportunism hypothesis. Further, consistent with the risk hypothesis, over the years prior to the estimate changes, companies are more prone to idiosyncratic risks such as going concern problems, misstatements, discontinued operations, corporate restructuring, charge-offs, and internal control problems. The lack of evidence supporting the opportunism hypothesis is not surprising because, under US GAAP, companies are required to disclose the “dollar effect” of an accounting estimate change on net income in their financial statements.
Keywords: change in accounting estimates, audit effort, audit fees, and earnings management
JEL Classification: M40, M41, M42
Suggested Citation: Suggested Citation