This paper provides a new approach to test for accrual-based earnings management. Our approach exploits the inherent property of accrual accounting that any accrual-based earnings management in one period must reverse in another period. If the researcher has priors concerning the timing of the reversal, incorporating these priors can significantly improve the power and specification of tests for earnings management. Our results indicate that tests incorporating reversals increase test power by around 40% and provide a robust solution for mitigating model misspecification arising from correlated omitted variables.
This study investigates firms subject to accounting enforcement actions by the Securities and Exchange Commission for alleged violations of Generally Accepted Accounting Principles. We investigate: (i) the extent to which the alleged earnings manipulations can be explained by extant eamings management hypotheses; (ii) the relation between eamings manipulations and weaknesses in firms' internal govemance structures? and (iii) the capital market consequences experienced by firms when the alleged eamings manipulations are made public. We find that an important motivation for eamings manipulation is the desire to attract external financing at low cost. We show that this motivation remains significant after controlling for contracting motives proposed in the academic literature. We also find that firms manipulating eamings are: (i) more likely to have boards of directors dominated by management; (ii) more likely to have a Chief Executive Officer who simultaneously serves as Chairman of the Board; (iii) more likely to have a Chief Executive Officer who is also the firm's founder, (iv) less likely to have an audit committee; and (v) less likely to have an outside blockholder. Finally, we document that firms manipulating eamings experience significant increases in their costs of capital when the manipulations are made public.Resume. Les auteurs analysent les entreprises assujetties aux mesures d'ex6cution prises par la Securities and Exchange Commission dans les cas de pr6somption de transgression des principes comptables g^neralement reconnus. Us s'interessent aux aspects suivants de la question: i) la mesure dans laquelle les pr^somptions de manipulations des benefices peuvent etre expliquees par les hypotheses existantes de gestion des b6n6fices; ii) la
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