Hostname: page-component-7dd5485656-s6l46 Total loading time: 0 Render date: 2025-10-30T08:35:16.365Z Has data issue: false hasContentIssue false
  • English
  • Français

Analyst Coverage and Real Earnings Management: Quasi-Experimental Evidence

Published online by Cambridge University Press:  02 May 2016

Rustom M. Irani  and
David Oesch
Rustom M. Irani*
Affiliation:
rirani@illinois.edu, University of Illinois, College of Business, Champaign, IL 61820
David Oesch
Affiliation:
david.oesch@business.uzh.ch, University of Zurich, Faculty of Business, Economics and Informatics, Zurich CH-8032, Switzerland.
*
*Corresponding author: rirani@illinois.edu
Get access Rights & Permissions [Opens in a new window]

Abstract

We study how securities analysts influence managers’ use of different types of earnings management. To isolate causality, we employ a quasi-experiment that exploits exogenous reductions in analyst following resulting from brokerage house mergers. We find that managers respond to the coverage loss by decreasing real earnings management while increasing accrual manipulation. These effects are significantly stronger among firms with less coverage and for firms close to the zero-earnings threshold. Our causal evidence suggests that managers use real earnings management to enhance short-term performance in response to analyst pressure, effects that are not uncovered when focusing solely on accrual-based methods.

Information

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 51 , Issue 2 , April 2016 , pp. 589 - 627
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2016 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Article purchase

Temporarily unavailable

References

Acharya, V., and Lambrecht, B.. “A Theory of Income Smoothing When Insiders Know More Than Outsiders.” Review of Financial Studies, 28 (2015), 2534–2574.CrossRefGoogle Scholar
Anantharaman, D., and Zhang, Y.. “Cover Me: Managers’ Responses to Changes in Analyst Coverage in the Post-Regulation FD Period.” Accounting Review, 86 (2012), 1851–1885.CrossRefGoogle Scholar
Armstrong, C. S.; Balakrishnan, K.; and Cohen, D. A.. “Corporate Governance and the Information Environment: Evidence from State Antitakeover Laws.” Journal of Accounting and Economics, 53 (2012), 185–204.CrossRefGoogle Scholar
Baber, W. R.; Fairfield, P. M.; and Haggard, J. A.. “The Effect of Concern about Reported Income on Discretionary Spending Decisions: The Case of Research and Development.” Accounting Review, 66 (1991), 818–829.Google Scholar
Balakrishnan, K.; Billings, M. B.; Kelly, B. T.; and Ljungqvist, A.. “Shaping Liquidity: On the Causal Effects of Voluntary Disclosure.” Journal of Finance, 69 (2014), 2237–2278.CrossRefGoogle Scholar
Barton, J., and Simko, P.. “The Balance Sheet as an Earnings Management Constraint.” Accounting Review, 77 (2002), 1–27.CrossRefGoogle Scholar
Bartov, E. “The Timing of Asset Sales and Earnings Manipulation.” Accounting Review, 68 (1993), 840–855.Google Scholar
Bartov, E.; Givoly, D.; and Hayn, C.. “The Rewards to Meeting or Beating Earnings Expectations.” Journal of Accounting and Economics, 33 (2002), 173–204.Google Scholar
Becker, C. L.; DeFond, M. L.; Jiambalvo, J.; and Subramanyan, K.. “The Effect of Audit Quality on Earnings Management.” Contemporary Accounting Research, 15 (1998), 1–24.CrossRefGoogle Scholar
Bens, D. A.; Nagar, V.; and Wong, M. F.. “Real Investment Implications of Employee Stock Option Exercises.” Journal of Accounting Research, 40 (2002), 359–393.CrossRefGoogle Scholar
Burgstahler, D., and Dichev, I.. “Earnings Management to Avoid Earnings Decreases and Losses.” Journal of Accounting and Economics, 24 (1997), 99–126.CrossRefGoogle Scholar
Bushee, B. J. “The Influence of Institutional Investors on Myopic R&D Investment Behavior.” Accounting Review, 73 (1998), 305–333.Google Scholar
Chen, S.-S., and Huang, C.-W.. “The Sarbanes-Oxley Act, Earnings Management, and Post-Buyback Performance of Open-Market Repurchasing Firms.” Journal of Financial and Quantitative Analysis, 48 (2013), 1847–1876.Google Scholar
Chen, T.; Harford, J.; and Lin, C.. “Do Analysts Matter for Governance? Evidence from Natural Experiments.” Journal of Financial Economics, 115 (2015), 383–410.Google Scholar
Clement, M. “Analyst Forecast Accuracy: Do Ability, Resources, and Portfolio Complexity Matter?” Journal of Accounting and Economics, 27 (1999), 285–303.Google Scholar
Cohen, D. A.; Dey, A.; and Lys, T.. “Real and Accrual-Based Earnings Management in the Pre- and Post-Sarbanes-Oxley Periods.” Accounting Review, 83 (2008), 757–787.Google Scholar
Cohen, D. A.; Pandit, S.; Wasley, C. E.; and Zach, T.. “Measuring Real Activity Management.” Working Paper, University of Texas at Dallas (2013).Google Scholar
Cohen, D. A., and Zarowin, P.. “Accrual-Based and Real Earnings Management Activities around Seasoned Equity Offerings.” Journal of Accounting and Economics, 50 (2010), 2–19.Google Scholar
Collins, D.; Pungaliya, R.; and Vijh, A.. “The Effects of Firm Growth and Model Specification Choices on Tests of Earnings Management in Quarterly Settings.” Working Paper, University of Iowa (2012).Google Scholar
Dechow, P. M.; Kothari, S. P.; and Watts, R. L.. “The Relation between Earnings and Cash Flows.” Journal of Accounting and Economics, 25 (1998), 133–168.Google Scholar
Dechow, P. M.; Richardson, S. A.; and Tuna, I.. “Why Are Earnings Kinky? An Examination of the Earnings Management Explanation.” Review of Accounting Studies, 8 (2003), 355–384.Google Scholar
Dechow, P. M., and Skinner, D. J.. “Earnings Management: Reconciling the Views of Accounting Academics, Practitioners, and Regulators.” Accounting Horizons, 14 (2000), 235–250.Google Scholar
Dechow, P. M., and Sloan, R. G.. “Executive Incentives and the Horizon Problem: An Empirical Investigation.” Journal of Accounting and Economics, 14 (1991), 51–89.Google Scholar
Dechow, P. M.; Sloan, R. G.; and Sweeney, A. P.. “Detecting Earnings Management.” Accounting Review, 70 (1995), 193–225.Google Scholar
Dechow, P. M.; Sloan, R. G.; and Sweeney, A. P.. “Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC.” Contemporary Accounting Research, 13 (1996), 1–36.Google Scholar
DeFond, M. L., and Jiambalvo, J.. “Incidence and Circumstances of Accounting Errors.” Accounting Review, 66 (1991), 643–655.Google Scholar
Degeorge, F.; Patel, J.; and Zeckhauser, R.. “Earnings Management to Exceed Thresholds.” Journal of Business, 72 (1999), 1–33.Google Scholar
Derrien, F., and Kecskes, A.. “The Real Effects of Financial Shocks: Evidence from Exogenous Changes in Analyst Coverage.” Journal of Finance, 68 (2013), 1407–1440.Google Scholar
Derrien, F.; Kecskes, A.; and Mansi, S.. “Information Asymmetry, the Cost of Debt, and Credit Events.” Working Paper, HEC Paris (2012).Google Scholar
Dyck, A.; Morse, A.; and Zingales, L.. “Who Blows the Whistle on Corporate Fraud?” Journal of Finance, 65 (2010), 2213–2253.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Industry Costs of Equity.” Journal of Financial Economics, 43 (1997), 153–193.Google Scholar
Fields, T. D.; Lys, T. Z.; and Vincent, L.. “Empirical Research on Accounting Choice.” Journal of Accounting and Economics, 31 (2001), 255–307.Google Scholar
Fong, K. Y. L.; Hong, H. G.; Kacperczyk, M. T.; and Kubik, J. D.. “Do Security Analysts Discipline Credit Rating Agencies?” Working Paper, New York University (2013).Google Scholar
Fuller, J., and Jensen, M. C.. “Just Say No to Wall Street: Putting a Stop to the Earnings Game.” Journal of Applied Corporate Finance, 14 (2002), 41–46.Google Scholar
Geiger, M. A., and Raghunandan, K.. “Auditor Tenure and Audit Reporting Failures.” Auditing: A Journal of Practice & Theory, 21 (2002), 67–78.Google Scholar
Gleason, C. A., and Lee, C. M. C.. “Analyst Forecast Revisions and Market Price Discovery.” Accounting Review, 78 (2003), 193–225.Google Scholar
Graham, J.; Harvey, C.; and Rajgopal, S.. “The Economic Implications of Corporate Financial Reporting.” Journal of Accounting and Economics, 40 (2005), 3–73.CrossRefGoogle Scholar
Grundfest, J., and Malenko, N.. “Quadrophobia: Strategic Rounding of EPS Data.” Working Paper, Stanford University (2012).Google Scholar
Hazarika, S.; Karpoff, J. M.; and Nahata, R.. “Internal Corporate Governance, CEO Turnover, and Earnings Management.” Journal of Financial Economics, 104 (2012), 44–69.Google Scholar
He, J., and Tian, X.. “The Dark Side of Analyst Coverage: The Case of Innovation.” Journal of Financial Economics, 109 (2013), 856–878.Google Scholar
Healy, P. M.; Hutton, A. P.; and Palepu, K. G.. “Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure.” Contemporary Accounting Research, 16 (1999), 485–520.Google Scholar
Healy, P. M., and Palepu, K. G.. “Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature.” Journal of Accounting and Economics, 31 (2001), 405–440.Google Scholar
Healy, P. M.; and Wahlen, J. M.. “A Review of the Earnings Management Literature and Its Implications for Standard Setting.” Accounting Horizons, 13 (1999), 365–383.CrossRefGoogle Scholar
Hirshleifer, D.; Hou, K.; Teoh, S. H.; and Zhang, Y.. “Do Investors Overvalue Firms with Bloated Balance Sheets?” Journal of Accounting and Economics, 38 (2004), 297–331.Google Scholar
Hong, H., and Kacperczyk, M.. “Competition and Bias.” Quarterly Journal of Economics, 125 (2010), 1683–1725.CrossRefGoogle Scholar
Hong, H.; Lim, T.; and Stein, J. C.. “Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies.” Journal of Finance, 55 (2000), 265–295.CrossRefGoogle Scholar
Hribar, P., and Collins, D. W.. “Errors in Estimating Accruals: Implications for Empirical Research.” Journal of Accounting Research, 40 (2002), 105–134.Google Scholar
Irani, R. M., and Oesch, D.. “Monitoring and Corporate Disclosure: Evidence from a Natural Experiment.” Journal of Financial Economics, 109 (2013), 398–418.Google Scholar
Jensen, M. C., and Meckling, W. H.. “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure.” Journal of Financial Economics, 3 (1976), 305–360.Google Scholar
Jones, J. J. “Earnings Management during Import Relief Investigations.” Journal of Accounting Research, 29 (1991), 193–228.Google Scholar
Karpoff, J. M.; Lee, D. S.; and Martin, G. S.. “The Consequences to Managers for Financial Misrepresentation.” Journal of Financial Economics, 88 (2008a), 193–215.Google Scholar
Karpoff, J. M.; Lee, D. S.; and Martin, G. S.. “The Cost to Firms of Cooking the Books.” Journal of Financial and Quantitative Analysis, 43 (2008b), 581–611.Google Scholar
Kedia, S., and Philippon, T.. “The Economics of Fraudulent Accounting.” Review of Financial Studies, 22 (2009), 2169–2199.CrossRefGoogle Scholar
Kelly, B. T., and Ljungqvist, A.. “The Value of Research.” Working Paper, New York University (2007).Google Scholar
Kelly, B. T., and Ljungqvist, A.. “Testing Asymmetric-Information Asset Pricing Models.” Review of Financial Studies, 25 (2012), 1366–1413.Google Scholar
Kothari, S.; Leone, A. J.; and Wasley, C. E.. “Performance Matched Discretionary Accrual Measures.” Journal of Accounting and Economics, 39 (2005), 163–197.Google Scholar
Lang, M. H., and Lundholm, R. J.. “Cross-Sectional Determinants of Analyst Ratings of Corporate Disclosures.” Journal of Accounting Research, 31 (1993), 246–271.Google Scholar
Leuz, C. “Discussion of ADRs, Analysts, and Accuracy: Does Cross-Listing in the United States Improve a Firm’s Information Environment and Increase Market Value?” Journal of Accounting Research, 41 (2003), 347–362.Google Scholar
Li, F. “Annual Report Readability, Current Earnings, and Earnings Persistence.” Journal of Accounting and Economics, 45 (2008), 221–247.Google Scholar
Lindsey, L., and Mola, S.. “Analyst Competition and Monitoring: Earnings Management in Neglected Firms.” Working Paper, Arizona State University (2013).Google Scholar
Matsunaga, S. R., and Park, C. W.. “The Effect of Missing a Quarterly Earnings Benchmark on the CEO’s Annual Bonus.” Accounting Review, 76 (2001), 313–332.Google Scholar
Mergenthaler, R. D.; Rajgopal, S.; and Srinivasan, S.. “CEO and CFO Career Penalties to Missing Quarterly Earnings Forecasts.” Working Paper, Harvard Business School (2012).Google Scholar
Mikhail, M. B.; Walther, B. R.; and Willis, R. H.. “Do Security Analysts Improve Their Performance with Experience?” Journal of Accounting Research, 35 (1997), 131–166.CrossRefGoogle Scholar
Mikhail, M. B.; Walther, B. R.; and Willis, R. H.. “The Effect of Experience on Security Analyst Underreaction.” Journal of Accounting and Economics, 35 (2003), 101–116.CrossRefGoogle Scholar
Myers, J. N.; Myers, L. A.; and Omer, T. C.. “Exploring the Term of the Auditor-Client Relationship and the Quality of Earnings: A Case for Mandatory Auditor Rotation?” Accounting Review, 78 (2003), 779–799.CrossRefGoogle Scholar
Palmrose, Z.-V. “Trials of Legal Disputes Involving Independent Auditors: Some Empirical Evidence.” Journal of Accounting Research, 29 (1991), 149–185.Google Scholar
Richardson, S.; Sloan, R.; Soliman, M.; and Tuna, I.. “Accrual Reliability, Earnings Persistence and Stock Prices.” Journal of Accounting and Economics, 39 (2005), 437–485.Google Scholar
Roberts, M. R., and Whited, T.. “Endogeneity in Empirical Corporate Finance.” In Handbook of the Economics of Finance, Vol. 2, Constantinides, G., Harris, M., and Stulz, R., eds. Amsterdam, Netherlands: Elsevier Science (2013), 493–572.Google Scholar
Rosenbaum, P., and Rubin, D.. “The Central Role of the Propensity Score in Observational Studies for Causal Effects.” Biometrika, 70 (1983), 41–55.Google Scholar
Roychowdhury, S. “Earnings Management through Real Activities Manipulation.” Journal of Accounting and Economics, 42 (2006), 335–370.Google Scholar
Sloan, R. G. “Do Stock Prices Reflect Information in Accruals and Cash Flows about Future Earnings?” Accounting Review, 71 (1996), 289–315.Google Scholar
Stice, J. D. “Using Financial and Market Information to Identify Pre-Engagement Factors Associated with Lawsuits against Auditors.” Accounting Review, 66 (1991), 516–533.Google Scholar
Wilkins, M. S., and Loudder, M. L.. “Articulation in Cash Flow Statements: A Resource for Financial Accounting Courses.” Journal of Accounting Education, 18 (2000), 115–126.Google Scholar
Wu, J., and Zang, A.. “What Determines Financial Analysts’ Career Outcomes During Mergers?” Journal of Accounting and Economics, 47 (2009), 59–86.Google Scholar
Yu, F. “Analyst Coverage and Earnings Management.” Journal of Financial Economics, 88 (2008), 245–271.Google Scholar
Zang, A. Y. “Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management.” Accounting Review, 87 (2012), 675–703.Google Scholar