Doing Good When Doing Well: Evidence on Real Earnings Management

Abstract

We provide evidence on earnings management by exploiting temporary exogenous shocks to
utility firms’ sales arising from weather variation. We find that sample firms’ sales are highly
sensitive to annual changes in average temperatures in the region where the firm operates, but this
sensitivity disappears quickly moving down the income statement. This evidence, while indirect,
is suggestive of earnings management activities. In search of direct evidence, we study charitable
giving decisions by sample firms and uncover a significant positive sensitivity of charitable
spending to weather-driven demand shocks, behavior that is highly consistent with the presence of
real earnings management efforts. We find no convincing evidence supporting possible alternative
explanations for this evidence, but we do find limited support for the presence of a larger
giving-weather relation when earnings management incentives are likely to be elevated. If other real
decisions with similar characteristics scale proportionally to charitable giving, our findings suggest
that the overall magnitude of real earnings management activities could be quite substantial.

Keywords: real earnings management; charitable giving; weather; regulated utilities

JEL Classification: M41, G31, G32, L21