Crossing the Red Line: An Examination of Inter-Temporal Shifts In Managers' Tendencies to Report Small Annual Profits*

60 Pages Posted: 23 Sep 2008 Last revised: 28 Nov 2018

See all articles by Atul Rai

Atul Rai

Wichita State University

Joseph Kerstein

Yeshiva University - Syms School of Business

Date Written: September 15, 2008

Abstract

Previous research suggest that managerial incentives to avoid annual losses have declined over time, as managers concentrate more on avoiding negative earnings surprises. However, since analysts' forecasts generally assume positive earnings, it is unclear whether managers face conflicts between these two earnings objectives. Furthermore, Jiang (2008) suggests that reporting profits is more important than reporting positive earnings surprises or earnings increases to maintain firms' debt costs of capital. We re-examine whether earnings management to avoid small annual losses has declined over time. To overcome limitations of the previous methodologies that infer earnings management using either the ex-post shape of the earnings distribution or structural models for estimating discretionary accruals, we adapt the Kerstein and Rai (2007) approach. We find little evidence to suggest that the tendency to avoid annual losses has declined. In fact, we find no evidence of a decline, even after the Sarbanes-Oxley Act of 2002. Our findings are robust to using either earnings scaled by beginning market value or EPS.

Keywords: Earnings management, analysts forecast, profits, earnings distribution

JEL Classification: M4, L14, C89

Suggested Citation

Rai, Atul and Kerstein, Joseph J., Crossing the Red Line: An Examination of Inter-Temporal Shifts In Managers' Tendencies to Report Small Annual Profits* (September 15, 2008). Available at SSRN: https://ssrn.com/abstract=1270833 or http://dx.doi.org/10.2139/ssrn.1270833

Atul Rai (Contact Author)

Wichita State University ( email )

1845 Fairmount Avenue
Wichita, KS 67260-0087
United States
316-978-6251 (Phone)
316-978-3660 (Fax)

Joseph J. Kerstein

Yeshiva University - Syms School of Business ( email )

United States

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