Evidence on Motivations for Downward Earnings Management

51 Pages Posted: 3 Aug 2006 Last revised: 15 May 2014

See all articles by Brad A. Badertscher

Brad A. Badertscher

University of Notre Dame

John D. Phillips

University of Connecticut - Department of Accounting

Morton Pincus

University of California, Irvine

Sonja O. Rego

Indiana University - Kelley School of Business - Department of Accounting

Date Written: April 22, 2009

Abstract

We analyze a set of firms that restated earnings upward because of accounting irregularities and thus presumably had managed earnings downward. Our results are consistent with the restatement sample firms having managed earnings downward in their original financial statements to create cookie jar reserves, to depress share prices prior to corporate and insider stock purchases, and to minimize political costs. There is no evidence these firms managed earnings downward to reduce income taxes, which is consistent with tax-motivated downward earnings management being accomplished via real transactions that typically do not give rise to accounting irregularities. We estimate that taxable firms (i.e., profitable restatement sample firms without NOL carryforwards) left an average of 23 cents per dollar of pre-tax earnings management on the table by engaging in book-tax nonconforming downward earnings management. The forgone tax savings represent a lower bound on the incremental costs associated with real transactions management.

Keywords: Earnings management, restatements, book-tax differences, book-tax conformity

JEL Classification: M41, M43, H25, M49

Suggested Citation

Badertscher, Brad A. and Phillips, John D. and Pincus, Morton P.K. and Rego, Sonja O., Evidence on Motivations for Downward Earnings Management (April 22, 2009). Available at SSRN: https://ssrn.com/abstract=921422 or http://dx.doi.org/10.2139/ssrn.921422

Brad A. Badertscher

University of Notre Dame ( email )

Mendoza College of Business
Notre Dame, IN 46556-5646
United States

John D. Phillips

University of Connecticut - Department of Accounting ( email )

School of Business
Storrs, CT 06269-2041
United States
860-486-2789 (Phone)
860-486-4838 (Fax)

Morton P.K. Pincus

University of California, Irvine ( email )

Irvine, CA 92697-3125
United States
949-824-4062 (Phone)
949-725-2812 (Fax)

Sonja O. Rego (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States
812 855-6356 (Phone)

HOME PAGE: http://kelley.iu.edu/Accounting/faculty/page12887.cfm?ID=33017

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