Prior research has investigated earnings management primarily through the use of discretionary accruals. We examine whether, in addition to discretionary accruals, firms further engage in earnings management using transactions with affiliated companies. When a parent company has a dominant relation over affiliated companies, the parent company can structure transactions between itself and affiliates in a way that allows it to achieve income-reporting objectives beyond the use of discretionary accruals. We address this research issue in Japan because Japanese firms issue both parent and consolidated financial statements. In addition to earnings management techniques that can be used to manage consolidated earnings, parent earnings can also be managed using transactions with affiliates. We find earnings management behavior for both parent and consolidated earnings around three earnings thresholds: avoiding losses, avoiding earnings declines, and avoiding negative forecast errors. Consistent with additional earnings management through affiliated transactions, parent earnings show stronger evidence of earnings management than consolidated earnings at each of these three earnings thresholds. Further tests indicate that the increased management of parent earnings around these three earnings thresholds is related to the firm's ability to use affiliated transactions, while the management of consolidated earnings is unrelated to the firm's ability to use affiliated transactions.

SYNOPSIS: Research shows that analysts following companies with a higher portion of foreign operations provide more optimistic forecasts, presumably to maintain favorable relations with management and thereby obtain improved access to information. We examine the effect of the introduction of Regulation Fair Disclosure (Reg FD) on analyst forecast bias for internationally diversified firms. We hypothesize that analysts’ incentives to issue optimistic forecasts for such firms should be reduced in the post-Reg FD era, because Reg FD prohibits firms from selectively disclosing management information to analysts. First, we demonstrate that average forecast bias decreases for our full sample of multinational firms. Second, we show that the positive relation between forecast optimism and international diversification significantly declines (and even disappears) in the post-Reg FD period. Reg FD appears to have been successful in reducing analysts’ optimistic bias and in reducing the effect of forecasting complexity on forecast bias for our sample of multinational firms. In a sensitivity test, we also find that the relation between international operations and forecast accuracy improves in the post-Reg FD period.

This study examines whether geographic information disclosed at an increasingly disaggregated level (specifically, consolidated vs. continent vs. country) results in increased predictive ability of company operations (specifically, sales, gross profit, and earnings). Multinational corporations (MNCs) are formed using a simulated merger approach by combining the annual operating results of six individual firms, one from each of six countries. This approach makes it possible to compare the forecasting accuracy of data disclosed at the country, continent, and consolidated levels, not possible using current geographic segment disclosures. Previous studies using year‐ahead forecast models implicitly assume the predictive factors included in the models are significant in forecasting operating results. Using regression forecast models, this study tests whether the predictive factors included in the models are effective in forecasting operating results by examining the direction, size, and significance of the regression coefficient estimates. The coefficients provide evidence that exchange rate changes, inflation, and real GNP growth are useful in forecasting annual sales and gross profit. Whereas, at least for this sample and this time period, exchange rate changes, inflation, and real GNP growth are not significant variables in forecasting annual earnings. The results indicate that the accuracy of forecasts increase as sales and gross profit are disclosed at a more disaggregated geographic level. The hypothesized relationship between consolidated, continent, and country levels, while holding strongly under perfect foresight, holds to a lesser extent using forecasts of exchange rates, inflation, and real GNP.