Maintaining a Reputation for Consistently Beating Earnings Expectations and the Slippery Slope to Earnings Manipulation

56 Pages Posted: 19 May 2015 Last revised: 4 Dec 2018

See all articles by Jenny Chu

Jenny Chu

University of Cambridge - Judge Business School

Patricia Dechow

USC Marshall School of Business

Kai Wai Hui

University of Hong Kong

Annika Yu Wang

University of Houston - Bauer College of Business

Date Written: November 16, 2018

Abstract

This paper investigates whether maintaining a reputation for consistently beating analysts’ earnings expectations can motivate executives to move from “within GAAP” earnings management to “outside of GAAP” earnings manipulation. We analyze firms subject to SEC enforcement actions and find that these firms consistently beat analysts’ quarterly earnings forecasts in the three years prior to the manipulation period and continue to do so by smaller “beats” during the manipulation period. We find that manipulating firms beat expectations around 86 percent of the time in the twelve quarters prior to the manipulation period (versus 75 percent for control firms) and that manipulation often ends with a miss in expectations. We document that executives of manipulating firms face strong stock market and CEO pressure to perform. Prior to the manipulation period, these firms have high analyst optimism, growing institutional interest, and high market valuations, along with powerful CEOs. Further, we find that maintaining a reputation for beating expectations is more important than CEO overconfidence and is incremental to CEO equity incentives for explaining manipulation. Our results suggest that pressure to maintain a reputation for beating analysts’ expectations can encourage aggressive accounting and, ultimately, earnings manipulation.

Keywords: earnings manipulation; consecutively beating earnings expectations; market pressure; CEO overconfidence; CEO power; reputation; reference-dependent preferences; analysts’ forecasts and recommendation; institutional investors; overvaluation

JEL Classification: G12, M41

Suggested Citation

Chu, Jenny and Dechow, Patricia and Hui, Kai Wai and Wang, Annika Yu, Maintaining a Reputation for Consistently Beating Earnings Expectations and the Slippery Slope to Earnings Manipulation (November 16, 2018). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2607219 or http://dx.doi.org/10.2139/ssrn.2607219

Jenny Chu

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

Patricia Dechow (Contact Author)

USC Marshall School of Business ( email )

Los Angeles, CA 90089-0441
United States

Kai Wai Hui

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, Pokfulam
Hong Kong

Annika Yu Wang

University of Houston - Bauer College of Business

Bauer College of Business
4250 Martin Luther King Blvd
Houston, TX 77204
United States

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