Earnings Management to Exceed Thresholds

TLDR

Earnings are crucial for investment decisions, and executives, motivated by self‑interest and stakeholder scrutiny, often manage earnings to influence these outcomes. The authors introduce behavioral thresholds that define when earnings management is likely to occur. A model demonstrates how thresholds trigger distinct earnings‑management tactics, and empirical analysis identifies management actions that exceed thresholds for positive profits, sustaining recent performance, and meeting analysts' expectations. The positive‑profits threshold dominates, and firms that push earnings just above this threshold exhibit poorer future performance than comparable control firms. © 1999 University of Chicago Press.

Abstract

Earnings provide important information for investment decisions. Thus, executives--who are monitored by investors, directors, customers, and suppliers--acting in self-interest and at times for shareholders, have strong incentives to manage earnings. The authors introduce behavioral thresholds for earnings management. A model shows how thresholds induce specific types of earnings management. Empirical explorations identify earnings management to exceed each of three thresholds: report positive profits, sustain recent performance, and meet analysts' expectations. The positive profits threshold proves predominant. The future performance of firms suspect for boosting earnings just across a threshold is poorer than that of control group firms. Copyright 1999 by University of Chicago Press.