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
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: Suggested Citation
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