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The effects of a public indicator of accounting aggressiveness on managers’ financial reporting decisions

Erin L. Hamilton (Department of Accounting, Lee Business School, University of Nevada, Las Vegas, Nevada, USA)
Rina M. Hirsch (Department of Accounting, Taxation and Legal Studies in Business, Frank G. Zarb School of Business, Hofstra University, Hempstead, New York, USA)
Jason T. Rasso (School of Accounting, University of South Carolina Darla Moore School of Business, Columbia, South Carolina, USA)
Uday S. Murthy (Lynn Pippenger School of Accountancy, Muma College of Business, University of South Florida, Tampa, Florida, USA)

Managerial Auditing Journal

ISSN: 0268-6902

Article publication date: 26 June 2019

Issue publication date: 7 October 2019

Abstract

Purpose

The purpose of this paper is to examine how publicly available accounting risk metrics influence the aggressiveness of managers’ discretionary accounting decisions by making those decisions more transparent to the public.

Design/methodology/approach

The experiment used a 2 × 3 between-participants design, randomly assigning 122 financial reporting managers among conditions in which we manipulated whether the company was currently beating or missing analysts’ consensus earnings forecast and whether an accounting risk metric was indicative of low risk, high risk or a control. Participants chose whether to manage company earnings by deciding whether to report an amount of discretionary accruals that was consistent with the “best estimate” (i.e. no earnings management) or an amount above or below the best estimate.

Findings

Aggressive (income-increasing) earnings management is deterred when managers believe such behavior will cause their firm to be flagged as aggressive (i.e. high risk) by an accounting risk metric. Some managers attempt to “manage” the risk metric into an acceptable range through conservative (income-decreasing) earnings management. These results suggest that by making the aggressiveness of accounting choices more transparent, public risk metrics may reduce one type of earnings management (income-increasing), while simultaneously increasing another (income-decreasing).

Research limitations/implications

The operationalization of the manipulated variables of interest may limit the study’s generalizability.

Practical implications

Users of accounting risk metrics (e.g. investors, auditors, regulators) should be cautious when relying on such risk metrics that may be of limited reliability and usefulness due to managers’ incentives to manipulate their companies’ risk scores by being overly conservative in an effort to prevent being labeled “aggressive”.

Originality/value

By increasing the transparency of the aggressiveness of accounting choices, public risk metrics may reduce one type of earnings management (income-increasing), while simultaneously increasing another (income-decreasing).

Keywords

Acknowledgements

This paper has benefited from feedback received from Jeffrey Hales, Jared Koreff, Aaron Saiewitz, and Scott Vandervelde, as well as workshop participants at North Carolina State University, University of Alabama, University of Nevada, Las Vegas, University of South Carolina, University of South Florida, and participants at the 2016 Forensic Accounting Research Conference. The work described in this paper was supported by the Institute of Management Accountants (IMA) and a summer research grant from Hofstra University’s Frank G. Zarb School of Business.

Citation

Hamilton, E.L., Hirsch, R.M., Rasso, J.T. and Murthy, U.S. (2019), "The effects of a public indicator of accounting aggressiveness on managers’ financial reporting decisions", Managerial Auditing Journal, Vol. 34 No. 8, pp. 986-1007. https://doi.org/10.1108/MAJ-07-2018-1955

Publisher

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Emerald Publishing Limited

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