Predicting Earnings Management: The Case of Earnings Restatements

41 Pages Posted: 30 Jan 2003  

Scott A. Richardson

AQR Capital Management, LLC; London Business School

A. Irem Tuna

London Business School

Min Wu

Morgan Stanley

Date Written: October 2002

Abstract

This paper examines the usefulness of accounting information in predicting earnings management. We investigate a comprehensive sample of firms from 1971-2000 that restated annual earnings. We find that firms restating earnings have high market expectations for future earnings growth and have higher levels of outstanding debt. We also find that a primary motivation for the earnings manipulation is the desire to attract external financing at a lower cost. Furthermore, our evidence suggests that restating firms have been attempting to maintain a string of consecutive positive earnings growth and consecutive positive quarterly earnings surprises. Together, our evidence is consistent with capital market pressures acting as a motivating factor for companies to adopt aggressive accounting policies. Finally, we document that information in accruals, specifically, operating and investing accruals, are key indicators of the earnings manipulation that lead to the restatement. Collectively, the evidence suggests that market participants can gain substantial value from a careful consideration of information in financial statements.

Keywords: voluntary disclosure, capacity competition, price competition, strategic interactions

JEL Classification: M41, M43, M45

Suggested Citation

Richardson, Scott A. and Tuna, A. Irem and Wu, Min, Predicting Earnings Management: The Case of Earnings Restatements (October 2002). Available at SSRN: https://ssrn.com/abstract=338681 or http://dx.doi.org/10.2139/ssrn.338681

Scott Anthony Richardson

AQR Capital Management, LLC ( email )

Greenwich, CT
United States

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Ayse Irem Tuna (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Min Wu

Morgan Stanley ( email )

Hong Kong

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