Earnings management to avoid earnings boosts

Abstract

Purpose

The purpose of this study is to investigate whether earnings boosts before the year end trigger earnings management. It examines whether firms that substantially outperformed their last year earnings during the first three quarters push their earnings down to avoid reporting earnings boosts.

Design/methodology/approach

Regression analysis is used to compare earnings management of firms with earnings boosts and other firms.

Findings

The results indicate that firms outperforming their last year results by the end of the third quarter manipulate their earnings downwards by means of real activities manipulation, while they do not indicate income-decreasing accruals management. It is also found that consistent with the prominent shift from accruals management to real activities manipulation, accruals management is less costly which justifies why it is used for downward manipulation.

Research limitations/implications

The results are limited to one single earnings benchmark i.e. last year earnings. Further research may individually or collectively examine other benchmarks including analysts' forecasts.

Practical implications

The findings suggest that users should be more vigilant of firms exceeding their last year interim results, as they could be involved in downward earnings management.

Originality/value

This study documents earnings management in a new setting where earnings boosts before the year end trigger downward manipulation of real activities.

Citation

Makarem, N. and Roberts, C. (2020), "Earnings management to avoid earnings boosts", Journal of Applied Accounting Research, Vol. 21 No. 4, pp. 657-676. https://doi.org/10.1108/JAAR-01-2019-0012