Earnings Management and Expectations Management: Implications for Analyst Rationality

41 Pages Posted: 30 Mar 2005

See all articles by Srinivasan Sankaraguruswamy

Srinivasan Sankaraguruswamy

National University of Singapore (NUS) - Department of Accounting

Richard J. Sweeney

Georgetown University - Department of Finance

Date Written: March 2005

Abstract

Prior literature has argued that managers manipulate earnings; other literature suggests that managers manipulate analysts (market) expectations of earnings. These two streams treat the two types of manipulation as occurring independently of each other. Our paper suggests that managers manipulate both earnings and expectations at the same time, and model them as jointly determined. In this model, errors in earnings and forecasts are positively correlated. In prior research the data reject the null that earnings forecasts are rational; in terms of this paper's model, these rejections are to be expected; given the positive correlation in errors between managers and analysts, prior tests are mis-specified. A non-zero forecast error on average is taken to mean that analysts are biased; this paper's model of joint determination predicates a non-zero forecast error on average. Similarly, this paper's model predicts rejection of rationality in other standard tests.

Keywords: Earnings management, Expectation management, Guidance, Analyst rationality

JEL Classification: G1, G2

Suggested Citation

Sankaraguruswamy, Srinivasan and Sweeney, Richard J., Earnings Management and Expectations Management: Implications for Analyst Rationality (March 2005). Available at SSRN: https://ssrn.com/abstract=683041 or http://dx.doi.org/10.2139/ssrn.683041

Srinivasan Sankaraguruswamy (Contact Author)

National University of Singapore (NUS) - Department of Accounting ( email )

1 Business Link
Singapore, 117592
Singapore
+65 6874 4473 (Phone)
+65 6779 2083 (Fax)

Richard J. Sweeney

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States

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