Information Content of Earnings Management: Evidence from Managing Earnings to Exceed Thresholds

54 Pages Posted: 26 Aug 2004

See all articles by Yanfeng Xue

Yanfeng Xue

George Washington University - Department of Accountancy

Date Written: December 2003

Abstract

This paper examines whether managers signal firms' future performance by managing earnings to exceed thresholds. Because managers' reporting discretion is bounded by the accounting regulations, managing earnings to exceed the current period's thresholds reduces future earnings, making future earnings thresholds more difficult to attain. As a result, only firms with sufficient future earnings growth can benefit from doing so. I test the signaling hypothesis in three steps. I first hypothesize that firms with a higher degree of information asymmetry between the management and investors are more likely to signal performance using earnings thresholds. Consistent with the hypothesis, I find that the discontinuities in earnings distributions around thresholds are significantly more salient for more information-strained firms. In the second step, I examine the credibility of the signal and document that firms that marginally exceed the earnings thresholds demonstrate superior future accounting performance compared with firms just missing the thresholds, and this difference in future performance increases with the degree of information asymmetry. The third step of my analysis studies the market's reaction to firms' beating or missing the thresholds. My empirical results suggest that the capital market recognizes the information content of the earnings management activities and rationally incorporates it in setting prices.

Suggested Citation

Xue, Yanfeng, Information Content of Earnings Management: Evidence from Managing Earnings to Exceed Thresholds (December 2003). Available at SSRN: https://ssrn.com/abstract=582601 or http://dx.doi.org/10.2139/ssrn.582601

Yanfeng Xue (Contact Author)

George Washington University - Department of Accountancy ( email )

School of Business and Public Management
Washington, DC 20052
United States

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