DP1790 Earnings Management to Exceed Thresholds

Author(s): François Degeorge, U Patel, Richard Zeckhauser
Publication Date: January 1998
Keyword(s): Behavioural Finance, earnings management, thresholds
JEL(s): G3
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=1790

Investors are keenly interested in financial reports of earnings because earnings provide important information for investment decisions. Thus, executives who are monitored by investors and directors face strong incentives to manage earnings. We introduce consideration of behavioural/institutional thresholds for earnings in this mix of incentives and governance. A model illustrates how thresholds induce specific types of earnings management. Empirical explorations find clear support for earnings management to exceed each of the three thresholds that we consider: positive profits, sustain-recent-performance, and meet-market-expectations. The thresholds are hierarchically ranked. The future performance of firms that possibly boost earnings to just cross a threshold appears to be poorer than that of less suspect control groups.