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Article
Publication date: 9 May 2016

Mary P. Mindak, Pradyot K. Sen and Jens Stephan

The purpose of this paper is to document at the firm-specific level whether firms manage earnings up or down to barely miss or meet/beat three common earnings threshold

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Abstract

Purpose

The purpose of this paper is to document at the firm-specific level whether firms manage earnings up or down to barely miss or meet/beat three common earnings threshold targets, namely, analysts’ forecasts (AFs), last year’s earnings and zero earnings, and whether the market rewards or punishes up versus down earnings management.

Design/methodology/approach

The authors assign each firm to its most likely earnings target using an algorithm that reflects management’s economic incentives to manage earnings. The authors place reported (managed) earnings in standard width intervals surrounding the earnings target. Jacob and Jorgensen’s (2007) proxy for unmanaged earnings is also placed into the intervals. Thus, a firm with unmanaged earnings in the interval just below the target and reported earnings in the interval just above the target would be deemed to have managed earnings up. The authors also document whether the market rewarded or punished the earnings management strategy with three-day cumulative abnormal returns.

Findings

The authors find that most firms which barely meet/beat their target did so by managing earnings up. The market rewarded this earnings management strategy. The market did not, however, reward firms that managed earnings down (i.e. created a cookie jar of reserves) to barely meet/beat their target. Thus, the meet/beat premium does not apply to all firms. The authors’ explanation is that most earnings targets are set by AFs; that these are usually the highest of the three targets; and that these are, therefore, considered to be “good” firms by the market because they have the ability to find that extra penny to meet/beat the target. Firms that were assigned to the last year’s earnings and/or zero earnings thresholds are not as “good” because they usually do not target the highest threshold and must manage earnings down, as they are more likely to have to reverse income-increasing accruals booked during interim quarters.

Research limitations/implications

The primary limitation in this study is the algorithm used to assign firms to their threshold target. It is ad hoc in nature, but relies on reasonable assumptions about the management’s incentives to manage earnings.

Practical implications

This study has practical implications because investors and regulators can adopt this methodology to identify potential candidates for earnings management that would allow further insight into accounting and reporting practices. This methodology may also be useful to the auditor who wants to understand the tendencies of a new client. It may also be a useful tool for framing auditing hypotheses in a way that would be appropriate for clients who manage earnings.

Originality/value

This paper documents for the first time at the firm-specific level the market reaction to upward versus downward earnings management designed to barely meet/beat the earnings threshold. It also documents the frequency with which firms target the three earnings thresholds and the frequency with which firms miss or meet/beat their threshold.

Details

Review of Accounting and Finance, vol. 15 no. 2
Type: Research Article
ISSN: 1475-7702

Keywords

Article
Publication date: 16 August 2021

Manish Bansal and Vivek Kumar

This study aims to investigate the impact of mandatory corporate social responsibility (CSR) spending legislation on the earnings management strategies of firms.

Abstract

Purpose

This study aims to investigate the impact of mandatory corporate social responsibility (CSR) spending legislation on the earnings management strategies of firms.

Design/methodology/approach

The authors use panel data regression models to analyze the data for this study. This study covers the post-legislation period, which spans over five years from the financial year ending March 2015 to the financial year ending March 2019.

Findings

The results show that firms manipulate accounting measures to avoid breaching the cut-off criteria for mandatory CSR. In particular, the results show that firms operating around the operating revenue threshold misclassify operating revenue as non-operating revenue. In contrast, firms operating around the net worth and net profit thresholds do downward real and accrual earnings management. These results are consistent with several robustness measures.

Originality/value

To the best of the authors’ knowledge, this is the first study that examines the impact of mandatory CSR spending on earnings management.

Details

Review of Accounting and Finance, vol. 20 no. 2
Type: Research Article
ISSN: 1475-7702

Keywords

Book part
Publication date: 13 August 2007

Timothy B. Folta and Jonathan P. O’Brien

We examine a central tenet of real option theory – whether real options influence managerial thresholds for investment. In contrast to prior studies that have focused on…

Abstract

We examine a central tenet of real option theory – whether real options influence managerial thresholds for investment. In contrast to prior studies that have focused on whether real options influence discrete investment decisions, our focus is on empirically isolating real options’ effects on thresholds. In particular, we examine the real options inherent in acquisition decisions. Our model posits that there are good reasons why we might expect there to be information asymmetry around the value of real options. Accordingly, if managers have unique information about growth options we might expect to observe them lowering their thresholds, perhaps to the point where they are willing to accept negative market returns. We further expect that the degree of information asymmetry for firm-specific growth options should be higher than for industry-specific growth options. Finally, we believe that managerial thresholds will be more prone to influence from growth options than deferment options. While thresholds are unobservable, we are able to isolate the effects of real options on acquisition thresholds by borrowing a method used originally in labor economics to isolate the determinants of reservation wages. Using a sample of over 28,000 acquisitions in the U.S., we find strong support for the model. These findings suggest that firms with low thresholds may choose to acquire despite comparatively low expected performance.

Details

Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

Article
Publication date: 30 July 2020

Xiaoxue Zhou, Yu Li and Yao Zhang

The purpose of this paper is to explore the threshold effect of firm size on technological innovation using panel data from 2007 to 2012 for listed enterprises in China's…

Abstract

Purpose

The purpose of this paper is to explore the threshold effect of firm size on technological innovation using panel data from 2007 to 2012 for listed enterprises in China's manufacturing sector.

Design/methodology/approach

Considering the aim of research question is to examine the nonlinear relationship, this paper utilizes the threshold regression proposed by Hansen's (2000).

Findings

Based on a threshold regression model using panel data from 2007 to 2012 for listed enterprises in China's manufacturing sector, we find a series of new results. This nonlinear relationship is under the restrictions and impacts of various factors, such as industry characteristics and government subsidies. The results suggest that the threshold regression model well explains the complicated nonlinear relationship and transition process, and it can also shed light on management practice and policy.

Originality/value

There are categorical arguments regarding why firm size is not as effective as before in explaining the monotonic principle of industrial innovation, especially for establishing an effective industrial policy in a particular situation. One of the important reasons is that we have begun to adopt a new perspective from the nonlinear view on the relationship between firm size and industrial innovation. In this study, we have examined the threshold effect of firm size on industrial technological innovation, which is the most representative nonlinear relationship.

Details

Journal of Economic Studies, vol. 48 no. 3
Type: Research Article
ISSN: 0144-3585

Keywords

Article
Publication date: 23 February 2010

Sherry Fang Li

Previous research has provided mixed evidence on the relative importance of three earnings thresholds that managers seek to achieve: avoiding losses, avoiding earnings…

Abstract

Purpose

Previous research has provided mixed evidence on the relative importance of three earnings thresholds that managers seek to achieve: avoiding losses, avoiding earnings declines and avoiding negative earnings surprises. The purpose of this paper is to investigate whether firm‐specific factors influence management's preferences for an earnings threshold.

Design/methodology/approach

Logit models are estimated to explore the relationships between firm‐characteristics and management's perceptions of the relative importance of each threshold.

Findings

This paper finds that: large firms, firms with high growth prospects and firms with high trading volume are more concerned with avoiding negative earnings surprises, while small firms, firms with low growth prospects and firms with low trading volume are more prone to avoid earnings declines and losses; for firms with high analyst forecast accuracy (relative to a random walk model forecast), avoiding negative earnings surprises is more important than avoiding earnings declines and losses; and firms with low analyst forecast dispersion focus more on avoiding negative earnings surprises and losses, while firms with high analyst forecast dispersion focus more on avoiding earnings declines. Overall, this paper shows that firm characteristics do affect management's perceptions of the relative importance of each threshold.

Originality/value

This study recognizes the cross‐sectional differences in the earnings threshold hierarchy. The results suggest that regulators and practitioners should focus on different thresholds for different types of firms when investigating the mechanisms used to achieve the thresholds.

Details

Review of Accounting and Finance, vol. 9 no. 1
Type: Research Article
ISSN: 1475-7702

Keywords

Article
Publication date: 2 March 2015

Galina Shirokova, Gina Vega and Dmitri Knatko

The purpose of this paper is to bring together a strategic choice perspective and an institutional perspective in order to address the key research questions: how do…

Abstract

Purpose

The purpose of this paper is to bring together a strategic choice perspective and an institutional perspective in order to address the key research questions: how do Russian founder-CEOs perceive the institutional environment when succession issues are taken into consideration?; how do the perceived characteristics of different formal and informal institutions affect the founder-CEO’s decision to delegate authority to a professional CEO?; and what are the main barriers to founder-CEO succession in threshold firms in emerging markets such as Russia?

Design/methodology/approach

Using a data set of 500 entrepreneurial companies from fast growing industries in Russia, the paper defines and studies threshold firms and analyses how various perceived characteristics of the institutional environment in emerging markets influence the likelihood of transition from founder management to professional management.

Findings

Institutional factors such as poor security of property rights and dependence of the business on relationships with government officials have a negative impact on the likelihood of founder-CEO succession in threshold firms in emerging markets. At the same time, the perception of contract law as insecure increases the likelihood of transition from founder management to professional management.

Originality/value

Most research on initial succession deals with internal organisational factors and does not consider external environments and their influence on founder-CEO departure and willingness to exit from company management. This study is unique in its focus on the external environment and institutional factors and their impact on management transitions in threshold firms in emerging economies.

Details

International Journal of Entrepreneurial Behavior & Research, vol. 21 no. 1
Type: Research Article
ISSN: 1355-2554

Keywords

Article
Publication date: 1 October 2006

Igor Filatotchev, Steve Toms and Mike Wright

The paper seeks to present a novel conceptual framework that integrates the strategic dynamics of the firm with changes in its governance systems.

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Abstract

Purpose

The paper seeks to present a novel conceptual framework that integrates the strategic dynamics of the firm with changes in its governance systems.

Design/methodology/approach

The agency research agenda is extended to include other corporate governance roles, such as resource and strategy functions, alongside monitoring and control functions. Theoretical arguments are supported by empirical data related to the founder‐manager/IPO, IPO/maturity, maturity/decline and reinvention thresholds.

Findings

The paper shows that corporate governance parameters may be linked to strategic thresholds in the firm's life‐cycle. Successful transition over a threshold is accompanied by a rebalancing in the structure and roles of corporate governance compared with each previous stage in the cycle.

Research limitations/implications

In the absence of longitudinal data relating to firms as they pass through all life‐cycle stages the study has been restricted to reporting illustrative data from different studies regarding each strategic threshold. Further research might usefully undertake detailed long‐term case studies using a combination of archival and interview data to trace the evolution of firms across the four thresholds.

Originality/value

This paper develops a novel conceptual framework that integrates the strategic dynamics of the firm with changes in its governance systems. It rejects the notion of a universal governance template and argues that corporate governance parameters may be linked to transitions from one stage to another in the firm's life‐cycle. Accordingly, it argues that changes in a firm's strategic positioning may be associated with rebalancing between the wealth‐protection and wealth‐creation functions of governance.

Details

International Journal of Managerial Finance, vol. 2 no. 4
Type: Research Article
ISSN: 1743-9132

Keywords

Book part
Publication date: 13 August 2007

Lihui Lin and Nalin Kulatilaka

Performance of firms in network industries depends much on the creation of standards around their technologies, products, or services. Establishing standards requires…

Abstract

Performance of firms in network industries depends much on the creation of standards around their technologies, products, or services. Establishing standards requires committing large, irreversible, upfront investment while demand remains uncertain. This paper focuses on the real options involved in this investment problem. The conventional real options literature recognizes the waiting-to-invest option where firms could avoid regret by waiting until at least some of the uncertainty is resolved. However, early commitment of network investment has vital strategic effects on shaping the expectations of potential users and inducing them to adopt the standard, thus creating a strategic growth option. We develop a simple model to explore the tradeoff between this strategic growth option and the waiting-to-invest option. We solve for the optimal investment rules and find that for high uncertainty, the strategic growth option often dominates the waiting-to-invest option and reduces the investment threshold. Furthermore, the intensity of network effect enhances the strategic growth option. Our results have important implications to the strategies of firms in technology industries.

Details

Real Options Theory
Type: Book
ISBN: 978-0-7623-1427-0

Book part
Publication date: 19 July 2005

Timothy B. Folta

I am interested in clarifying the discussion of how researchers might try to isolate real option effects to identify whether managerial decisions are guided by a real…

Abstract

I am interested in clarifying the discussion of how researchers might try to isolate real option effects to identify whether managerial decisions are guided by a real option heuristic. If we are to claim that the theory of real options illuminates managerial behavior, then as a field, we must converge on an understanding as to what constitutes a real option effect, and what does not. The discussion centers on hypothesis development, measurement issues, and research methodology.

Details

Research Methodology in Strategy and Management
Type: Book
ISBN: 978-0-76231-208-5

Article
Publication date: 20 July 2012

R. Mithu Dey and Mary W. Sullivan

The purpose of this paper is to estimate the cost of the internal control audit for small firms and assess whether the costs are scalable or, alternatively, whether they…

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Abstract

Purpose

The purpose of this paper is to estimate the cost of the internal control audit for small firms and assess whether the costs are scalable or, alternatively, whether they are higher in relation to firm size for small firms than for larger firms.

Design/methodology/approach

The method estimates the Section 404 audit fee premium for companies that became accelerated filers for the first time in 2006 and 2007. The authors use the estimated audit fee premium as a proxy for the premium that non‐accelerated filers would have to pay if they were required to obtain an internal control audit.

Findings

The main finding shows that the Section 404(b) estimated cost of the internal control audit divided by assets are significantly higher for non‐accelerated filers and first‐time filers than for those of larger firms.

Research limitations/implications

One limitation of the study is that, while it shows that the costs of the Section 404 audit are not scalable to firm size, it does not prove that the costs of the audit exceed the benefits for non‐accelerated filers.

Practical implications

The finding that the costs are proportionately higher for small firms provides some evidence supporting the decision to permanently exempt non‐accelerated filers from Section 404(b).

Originality/value

The results show that smaller firms pay proportionately more for the Section 404 internal control audit than larger firms. This suggests that the revised AS no. 5 did not succeed in making the internal control audit completely scalable to firm size.

Details

Managerial Auditing Journal, vol. 27 no. 7
Type: Research Article
ISSN: 0268-6902

Keywords

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