Auditing Section Research Summaries Space

A Database of Auditing Research - Building Bridges with Practice

This is a public Custom Hive  public

research summary

    Discontinuities and Earnings Management: Evidence from...
    research summary posted April 17, 2014 by Jennifer M Mueller-Phillips, tagged 06.0 Risk and Risk Management, Including Fraud Risk, 06.06 Earnings Management, 14.0 Corporate Matters, 14.01 Earnings Management, 14.05 Earnings Targets and Management Behavior 
    109 Views
    Title:
    Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation
    Practical Implications:

    The results of this study provide important evidence to the earnings management literature. Recent studies provide several plausible alternative explanations for the discontinuities in earnings distributions near earnings benchmarks. Though the findings of this study cannot readily be extrapolated to a broader sample of firms, the authors found evidence that firms commit less egregious earnings management in order to meet earnings benchmarks. This study is therefore important in considering whether earnings management plays a role in the discontinuities in various earnings distributions documented by prior studies.

    For more information on this study, please contact Dain C. Donelson.
     

    Citation:

    Donelson, D. C., J. M. McInnis, and R. D. Mergenthaler. 2013. Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation. Contemporary Accounting Research 30 (1).

    Keywords:
    earnings management; financial restatements; class action lawsuits; descriptive statistics.
    Purpose of the Study:

    A heated debate exists as to whether discontinuities in earnings distributions are indicative of earnings management. Many executives indicate that they would manage earnings within GAAP principles to achieve earnings benchmarks. This study examines the impact of earnings management on the discontinuity in earnings distributions near important benchmarks for a sample of firms where the amount of earnings is measurable. The authors look to find evidence linking earnings management to discontinuities in earnings distributions of this sample.

    Design/Method/ Approach:

    To determine the appropriate sample, this study utilizes the Securities Class Action Services (SCAS) database of historical class action data from RiskMetrics Group. From this database, the authors selected lawsuits that (1) settle and allege fraudulent GAAP violations and (2) involve restatements by firms for periods during which the alleged accounting fraud occurred. To identify and measure earnings management, the study utilizes the COMPUSTAT Point-in-Time database and uses descriptive statistics to compile evidence.

    Findings:
    • Earnings management drives the discontinuities in distribution of analyst forecast errors and earnings changes for sample firms.
    • Discontinuity is linked to earnings management.
    • The sensitivity to the scaling variable could indicate that factors other than earnings management contribute to the discontinuity in the sample.
    • Actual instances of earnings management do create sizable discontinuities in firms’ earnings distribution.
       
    Category:
    Corporate Matters, Risk & Risk Management - Including Fraud Risk
    Sub-category:
    Earnings Management, Earnings Management, Earnings Targets & Management Behavior