Firms often change their operating policy to meet a short-term financial reporting target. Accounting researchers call this opportunistic action real earnings management (REM). They measure REM by the difference between a firm’s costs and those reported by its industry peers. Firms that pursue distinct competitive strategies also display different cost patterns than peers. However, the models that measure REM do not control for differences in competitive strategy. Hence a researcher can misinterpret a cost difference that stems from a firm’s competitive strategy as REM. The researcher would also find a spurious correlation between earnings management and a firm characteristic that varies with competitive strategy. A cause or effect relationship with earnings management could be wrongfully inferred. I suggest improvements in measurement models to avoid misspecification

We provide evidence on earnings management by exploiting temporary exogenous shocks to utility firms’ sales arising from weather variation. We find that sample firms’ sales are highly sensitive to annual changes in average temperatures in the region where the firm operates, but this sensitivity disappears quickly as one moves down the income statement. This evidence, while indirect, is suggestive of earnings management activities. In search of direct evidence, we study charitable giving decisions by sample firms and uncover a significant positive sensitivity of charitable spending to weather-driven demand shocks, behavior that is highly consistent with the presence of real earnings management efforts. We find no convincing evidence supporting possible alternative explanations for this evidence, but we do find limited support for the presence of a larger giving–weather relation when earnings management incentives are likely to be elevated. If other real decisions with similar characteristics scale proportionally to charitable giving, our findings suggest that the overall magnitude of real earnings management activities could be quite substantial

Using data from China, we examine whether and how the incentive to boost GDP growth at the government level affects earnings management at the firm level. We find that firms in provinces with GDP growth lower than the national level or the average of the adjacent provinces are more likely to engage in earnings management than firms in other provinces. Specifically, they are more likely to inflate revenues, overproduce, and delay asset impairment losses. The aggregate earnings management induced by GDP growth incentives accounts for about 0.5% of GDP. The results are stronger for local state-owned enterprises, in provinces with a lower level of marketization, for firms in provinces with younger governors, and in the years immediately prior to the turnover of provincial officials. Overall, this paper provides systematic evidence on how firms engage in earnings management to boost the GDP growth in their provinces

We examine whether recent regulatory reforms requiring majority board independence reduce the extent of earnings management. Firms that did not have a majority of independent directors before the reforms (referred to as noncompliant firms) are required to increase their board independence. We find that, while noncompliant firms on average do not experience a significant decrease in earnings management after the reforms compared to other firms, noncompliant firms with low information acquisition cost experience a significant reduction in earnings management. The results are similar when we examine audit committee independence and when we use alternative proxies for information acquisition cost and earnings management. These findings indicate that independent directors’ monitoring is more effective in a richer information environment

We examine how cross-country differences in product, capital, and labor market competition, as well as earnings management affect mean reversion in accounting return on assets. Using a sample of 48,465 unique firms from 49 countries, we find that accounting returns mean revert faster in countries where there is more product and capital market competition, as predicted by economic theory. Country differences in labor market competition and earnings management are also related to mean reversion in accounting returns—but the relation varies with firm performance. Country labor competition increases mean reversion when unexpected returns are positive but slows it when unexpected returns are negative. Accounting returns in countries with higher earnings management mean revert more slowly for profitable firms and more rapidly for loss firms. Thus earnings management incentives to slow or speed up mean reversion in accounting returns are accentuated in countries where there is a high propensity for earnings management. Overall, these findings suggest that country factors explain mean reversion in accounting returns and are therefore relevant for firm valuation

The Gong, Young, and Zhou (GYZ) (Gong et al. 2023) paper examines potential earnings management by movie studio companies. Using a large sample of 3094 US-produced English-language movies released between 1997 and 2019, they find that movie studio companies, when faced with a below expected US box office revenue yield from their movies in a specific quarter, move up the release dates of movies with high expected revenues. This “move-up” release is an example of what the accounting research literature calls real earnings management. This commentary on GYZ (Gong et al. 2023) adds more structure to the decision-making context in which movie release dates are set, placing greater emphasis on the role of movie screening companies, which have the final say on the release dates for the movies they show on their screens. It also highlights the rich information setting that exists in the motion picture industry, which can be further exploited to probe the reliability of the earnings management findings reported by GYZ (Gong et al. 2023). This rich information includes security analyst reports and screen days available to quarter-end for each movie released. The commentary has relevance for other research in specific industries where the institutional domain has the potential to provide insight into real earnings management

We condition security price reactions to quarterly earnings announcements on whether firms disclose supplementary balance sheet and/or cashflow information that can be used to estimate the consequences of earnings management. Disclosure of supplementary information is voluntary, and thus, we consider the possibility that firms that disclose balance sheet and/or cashflow information differ systematically from firms that do not disclose. Results indicate that investors discount evidence of earnings management at the disclosure date when supplementary information is disclosed. Such results indicate more informed earnings interpretations of quarterly earnings when firms provide balance sheet and/or cashflow information concurrently

We study the relationship between the amount of managed earnings and firms’ earnings performance and expected growth in a reporting model, where managers manipulate earnings to influence the valuation of firms’ equity while bearing a cost that is increasing and convex in the amount of managed earnings. In the unique revealing equilibrium to the model, firms with higher performance and growth over-report earnings by a larger amount because price responsiveness increases with earnings performance and growth. And earnings quality, defined as the proportion of true economic earnings in total reported earnings, increases with earnings performance but decreases with earnings growth. We conduct empirical tests on a large sample and a restatement sample using different proxies for earnings management. Results from the large sample tests support our predictions while results from the restatement sample tests are mixed. Our study provides an alternative explanation to the positive relationship between discretionary accruals estimated from the Jones model and firms’ performance and growth

This paper examines earnings management in response to changes in tax planning and financial reporting incentives around the corporate income tax rate decrease from 35% to 21% enacted by Tax Cuts and Jobs Act (TCJA) of 2017. Given the higher level of book-tax conformity of real activities manipulation (RAM) relative to accrual-based earnings management (AEM), we hypothesize that firms concertedly use these techniques for different purposes. Specifically, we predict and find that firms use RAM to reduce taxable income prior to the TCJA with firms in our sample saving between $9.1 billion and $11.0 billion in taxes by shifting taxable income from the high-tax to the low-tax period. We also predict and find that firms use AEM, which has lower book-tax conformity than RAM, to simultaneously increase book income in the high-tax period. These results inform policymakers, regulators, and researchers on the economic effects of corporate tax reform

Prior studies on real earnings management (REM) focus mainly on estimating abnormal operating and investing activities at the firm level. We extend this literature by providing micro-level evidence regarding how financial reporting pressures influence new product release decisions, or product-level REM. Specifically, we compare how public and private studios differentially time the release of their movies. We find that, faced with pressure to boost quarterly revenues and earnings, public studios are more likely to release movies with high expected revenues in the last month of a fiscal quarter, compared to private studios. This documented result is stronger for firms with recent poor past performance, but is not present for movies in genres with a more targeted release window (e.g., romance and horror movies) and those using directors who have a history of collaboration with the studio. These results suggest that studios choose REM activities that have a lower impact on consumer demand and that minimize conflict with talent, consistent with choosing less costly activities to achieve financial reporting goals. A negative consequence of this financial reporting–driven product release strategy is that movies released in the last month of a quarter have lower international box office revenues. Taken together, these results provide evidence of the existence and consequences of product-level REM