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