TY - JOUR
T1 - Discontinuities and earnings management
T2 - Evidence from restatements related to securities litigation
AU - Donelson, Dain C.
AU - Mcinnis, John M.
AU - Mergenthaler, Richard D.
PY - 2013/3
Y1 - 2013/3
N2 - 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.
AB - 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.
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U2 - 10.1111/j.1911-3846.2012.01150.x
DO - 10.1111/j.1911-3846.2012.01150.x
M3 - Article
AN - SCOPUS:84875506398
SN - 0823-9150
VL - 30
SP - 242
EP - 268
JO - Contemporary Accounting Research
JF - Contemporary Accounting Research
IS - 1
ER -