A heated debate exists as to whether discontinuities in earnings distributions are indicative of earnings management. While many studies attribute discontinuities in earnings distributions to earnings management, other studies argue that earnings discontinuities are artifacts of sample selection and research design. Overall, there is limited direct evidence of a connection between earnings discontinuities and earnings management. In this study, we provide direct evidence linking earnings management to earnings discontinuities for a sample of firms that settle securities class action lawsuits and restate earnings from the alleged GAAP violation period. We compare the distribution of restated (“unmanaged”) earnings to originally reported (“managed”) earnings. We find that discontinuities are not present in the distribution of analyst forecast errors and earnings changes using unmanaged earnings but are present using managed earnings. The discontinuity in the earnings level distribution is attenuated, but not eliminated, on an unmanaged basis. These shifts among our sample of firms are caused by earnings management and cannot be explained by sample selection or research design issues. Our findings are important because many studies use earnings discontinuities as a proxy for intentional earnings manipulations and we provide the first direct evidence of a link between these two phenomena

This is the first study to establish a link between product market power of firms and the degree of earnings management. We hypothesize and document a significant and robust association between (a) a firm’s product market pricing power and its degree of earnings management, and (b) industry competitiveness and the degree of earnings management in the industry. Our study reveals that firms with inferior product market pricing power engage in greater discretionary earnings accruals, adding a new dimension to our understanding of the transparency and informativeness of firms’ financial statements. These findings are mirrored at the industry level where we document that more competitive industries are associated with greater earnings manipulation. The empirical evidence has direct implication on the informativeness and earnings quality of firms based on their product market power and competitiveness

We examine how the Sarbanes-Oxley Act (SOX) affects pre-repurchase earnings management and its association with post-repurchase firm performance. Unlike prior pre-SOX studies, our post-SOX results indicate that open-market repurchasers do not engage in pre-buyback downward accrual-based earnings management. Audit committee independence, reforms in corporate governance structures, and changes in executives’ equity holdings prompted by SOX may explain the findings. Post-SOX, the significant negative association between pre-repurchase abnormal accruals and post-repurchase performance disappears, the market reaction to repurchase announcements becomes significantly less favorable, and there is no evidence of any shift away from accrual-based to real earnings management

We test whether earnings management spreads between firms via shared directors. We find that a firm is more likely to manage earnings when it shares a common director with a firm that is currently managing earnings and is less likely to manage earnings when it shares a common director with a non-manipulator. Earnings management contagion is stronger when the shared director has a leadership or accounting-relevant position (e.g., audit committee chair or member) on its board or the contagious firm's board. Irregularity contagion is stronger than error contagion. The board contagion effect is robust to controlling for endogenous matching of firms with directors, fixed firm/director effects, incidence of M&A, industry, and contagion via a common auditor or geographical proximity. These findings support the view that board monitoring plays a key role in the contagion and quality of firms' financial reports. JEL Classifications: M40; M41; M49; G34; G39; D83. Data Availability: Data are available from sources identified in the text

This paper investigates the effect of venture capitalist (VC) quality on earnings management in firms conducting initial public offerings of their equity stock, focusing on manipulation of both accruals and real activities. I develop a measure of VC quality based on a principal components factor analysis using data that are obtainable for virtually all VC firms. This metric is highly correlated with VC funds’ financial returns, and with the likelihood of successful exits through initial public offerings or trade sales. After going public, companies backed by higher quality VCs have lower abnormal accruals, lower earnings management through real activities manipulation, and a lower likelihood of financial restatement. Companies backed by top‐quartile VCs do not appear to engage in real activities manipulation as a substitute for accruals manipulation. Companies backed by lower‐tier VCs exhibit earnings management behaviors which are indistinguishable from those of non‐VC‐backed companies. The results continue to hold when controlling for endogeneity. Overall, the results suggest that higher quality VCs are better able to constrain opportunistic financial reporting by their portfolio companies going public

This paper formalizes a two-step representation of accounting measurement and uses it to formalize a general rationale for conservatism as a measurement principle. A transaction's economic substance manifests itself in characteristics of the transaction, and an accounting rule is a mapping from transaction characteristics to an accounting report. Managers who have stakes in the accounting report are able to influence transaction characteristics. Such earnings management is ex post rational for managers but ex ante inefficient. To safeguard against such ex post opportunism, the optimal ex ante accounting rule is conservative in the sense that it requires more verification of the transaction characteristics favorable to managers. Thus, this rationale for conservatism is as general as the managers' ability and incentive to inflate transaction characteristics. By opening the black box of accounting measurement, the two-step representation also formalizes some classic accounting concepts, such as relevance, reliability, verifiability, verification, and accounting-motivated transactions

In an attempt to explain the weak evidence of priced exchange rate risk, we hypothesize that in addition to currency derivative usages, earnings management serves as another factor contributing to a reduction in exchange rate exposure. Our evidence reveals that earnings management activities, particularly those undertaken for the purpose of income smoothing, significantly reduce firm-specific exchange rate exposure, and that such role is particularly important if appropriate currency derivative instruments are limited. These results complement prior attempts to explain the puzzle of unpriced exchange rate risk. The investigation also highlights the importance of recognizing different managerial purposes behind discretionary accruals

This paper examines whether firms that deviate from an empirically modeled (“expected”) credit rating engage in earnings management activities, as measured by abnormal accruals and real activities earnings management. We find evidence that firms use income-increasing (-decreasing) earnings management activities when they are below (above) their expected ratings. We then test whether such actions are successful in helping these firms move toward their expected credit ratings. The results suggest that firms below or above their expected credit ratings may be able to move toward expected ratings through the use of directional earnings management

We provide evidence consistent with firm managers opportunistically defining non-GAAP earnings in order to meet or beat analyst expectations. This result is robust to controlling for other tools of benchmark beating (e.g., discretionary accruals, real earnings management, and expectation management). We also find that managers tend to exclude more expenses from non-GAAP earnings when it is costlier to use accrual earnings management due to balance sheet constraints, indicating that these tools are substitutes. Lastly, we find that investors discount positive earnings surprises when accompanied by exclusions from GAAP earnings, suggesting that the market partially understands the opportunistic nature of these exclusions. Our evidence is consistent with managers opportunistically defining non-GAAP earnings in a way that analysts fail to fully anticipate, resulting in an increased likelihood of exceeding analyst forecasts