Penny-Wise and Pound-Foolish: Does Striving to Meet Earnings Expectations by Manipulating Real Activities Undermine Product Quality?

Posted: 6 Jul 2021 Last revised: 30 Jul 2021

See all articles by Yangyang Chen

Yangyang Chen

City University of Hong Kong (CityU) - Department of Accountancy

Lijun Ma

University of International Business and Economics (UIBE)

Jeffrey Pittman

Memorial University ; Virginia Tech

Xin Yang

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: July 30, 2021

Abstract

We examine whether managers’ activities in striving to reach earnings targets affect their firms’ product quality. We find that firms suspected of manipulating real activities in trying to meet earnings benchmarks exhibit a higher likelihood and frequency of product recalls. Other evidence implies that high earnings pressure induces managers to manipulate real activities, resulting in more product quality failures. In cross-sectional results consistent with expectations, we find that the impact of exploiting real activities to attain earnings benchmarks on product recalls intensifies for firms whose managers have stronger incentives to manage earnings and subsides for firms subject to greater customer power and firms with more growth opportunities. Additional analysis shows that suspected benchmark targeting also raises the severity of product recalls.

Keywords: product quality, product recalls, earnings expectations, real activities management

JEL Classification: G10, L15, M40, M41

Suggested Citation

Chen, Yangyang and Ma, Lijun and Pittman, Jeffrey A. and Yang, Xin, Penny-Wise and Pound-Foolish: Does Striving to Meet Earnings Expectations by Manipulating Real Activities Undermine Product Quality? (July 30, 2021). Available at SSRN: https://ssrn.com/abstract=3871509

Yangyang Chen (Contact Author)

City University of Hong Kong (CityU) - Department of Accountancy ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong
China

Lijun Ma

University of International Business and Economics (UIBE) ( email )

10, Huixin Dongjie
Changyang District
Beijing, Beijing 100029
China

Jeffrey A. Pittman

Memorial University ( email )

St. John's, Newfoundland A1B 3X5
Canada
709-737-3100 (Phone)
709-737-7680 (Fax)

Virginia Tech ( email )

United States

Xin Yang

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
637
PlumX Metrics