Reviews the book `Auditing Symposium IX: Proceedings of the 1988 Touche Ross/University of Kansas Symposium on Auditing Problems,' edited by Rajendra P. Srivastava and James E. Rebele.
The recent spate of fraudulent financial reporting in the U.S. has drawn attention to the fact that the Chief Financial Officer (CFO) has a substantial amount of control over a firm's reported financial results. This paper examines the changes in discretionary accruals surrounding the appointment of a new CFO. Using a sample of 712 companies that appointed a new CFO in the period 1994 to 2000, we find that discretionary accruals decreased significantly following the appointment of a new CFO. Our tests indicate that this reduction is significantly greater for our group of CFO-hiring firms than for a control group of non-hiring firms, and that the changes are not driven by a concurrent appointment of a new Chief Executive Officer (CEO). We also find that our results are largely driven by firms that hire a new CFO from outside the company. Our study extends earlier research by providing empirical evidence that individuals in CFO positions wield significant influence over the firm's reported financial results and that a firm's discretionary accruals are significantly reduced surrounding the appointment of a new CFO.
Prior earnings management research often focuses on specific accounts or on estimations of discretionary accruals but provides only limited insight into the methods firms actually use to manage earnings. In order to begin exploration of some of the operational details regarding how earnings are managed, we investigate whether firms time their decisions to make changes in accounting estimates (CAEs) in consideration of their earnings benchmarks. Using CAE data across all accounts from 2006 to 2018, we find that 28.1% of income‐increasing CAEs are implemented in quarters where pre‐CAE earnings are below a forecasted earnings benchmark but inclusion of the CAE effectively allows the firm to meet the benchmark. We find that income‐increasing CAEs are more likely implemented when a firm's pre‐CAE earnings are further below the benchmark. We also find that firms are more likely to implement income‐decreasing CAEs under two scenarios: (i) when pre‐CAE earnings are relatively high, as a way either to smooth earnings or to “bury bad news,” and (ii) when pre‐CAE earnings are already low, as a way to take a financial “big bath” and position the firm for positive future earnings. In addition, we present evidence that firms using CAEs to achieve an earnings benchmark face financial consequences in terms of poorer immediate stock price performance and subsequent return on assets. Our conclusions hold after performing several additional analyses, including consideration of other discretionary options, addressing endogeneity concerns, and conducting falsification tests. In sum, we contribute to the earnings management literature by presenting consistent evidence that firms appear to time CAEs to meet earnings benchmarks or achieve other reporting objectives.