Causes and Consequences of Aggressive Financial Reporting Policies

Posted: 28 Jul 1999

See all articles by Patricia M. Dechow

Patricia M. Dechow

University of Southern California - Leventhal School of Accounting; University of California, Berkeley - Accounting Group

Richard G. Sloan

University of Southern California - Leventhal School of Accounting

Amy P. Hutton

Boston College - Carroll School of Management

Date Written: July 1994

Abstract

This paper investigates the motivations for managers' decisions to overstate earnings and examines the consequences of such decisions. We examine firms subject to enforcement actions by the Securities and Exchange Commission for having violated the financial reporting requirements of the securities laws. In addition to considering the traditional bonus and debt hypotheses as motivations for earnings management, we also investigate the hypothesis that earnings management is systematically related to firms' demands for external financing. We argue that by employing aggressive accounting policies, firms temporarily inflate their market values and temporarily reduce their costs of capital. Thus, managers of firms with high current demands for external financing have incentives to increase reported earnings. Further, we argue that aggressive reporting is more likely to occur in firms with poor governance structures. The empirical evidence supports our predictions. Relative to a matched control sample, aggressive reporters are in greater need of external financing and have poor governance structures. They have fewer outsiders on their boards of directors; are more likely to have their chief executive officers be chairmen of their boards; are less likely to have audit committees; and are less likely to have large outside blockholders. We also investigate the consequences of aggressive reporting. When management are identified as aggressive reporters, their firms' stock prices fall and they face less liquid markets for their securities and higher costs of capital.

JEL Classification: G14, G3, M4

Suggested Citation

Dechow, Patricia M. and Sloan, Richard G. and Hutton, Amy P., Causes and Consequences of Aggressive Financial Reporting Policies (July 1994). Available at SSRN: https://ssrn.com/abstract=5485

Patricia M. Dechow

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

University of California, Berkeley - Accounting Group ( email )

Haas School of Business
Berkeley, CA 94720
United States

Richard G. Sloan

University of Southern California - Leventhal School of Accounting ( email )

Los Angeles, CA 90089-0441
United States

Amy P. Hutton (Contact Author)

Boston College - Carroll School of Management ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States
617 552 1951 (Phone)

Register to save articles to
your library

Register

Paper statistics

Abstract Views
3,573
PlumX Metrics