Can External Monitoring Affect Corporate Financial Reporting and Disclosure? Evidence from Earnings and Expectations Management

Abstract

SYNOPSIS This study examines whether financial analysts and institutional investors play a disciplinary role in monitoring corporate financial reporting and disclosure. Using a sample of firms that meet or marginally beat analysts' forecasts, likely through upward earnings management and downward expectations management, this study shows that managers' use of the two tactics is associated with monitoring measures, including analyst following, analyst experience and independence, institutional ownership, and institutional investors' experience and investment style. Managers under more effective monitoring by analysts and institutional investors are more likely to manage expectations downward than to manage earnings upward. Overall, the findings are consistent with financial analysts and institutional investors playing a monitoring role in constraining distortions in reported earnings and inducing timely disclosure of bad news. Data Availability: All data are from public sources.

“Governance and corruption: is history repeating itself?” Fostering a debate and inviting contributions from a multidisciplinary perspective

“…Previous studies have mostly focused on the role of financial analysts and the media on corporate fraud detection and as a curb on earnings management (e.g. Yu 2008;DeGeorge et al 2013;Liu 2014). Some exploratory research is emerging on how they could influence impression management practices (e.g.…”

A Challenge to Business Leaders to End Earnings Management

“…Company leaders know they will have to face FA questions at every quarterly earnings conference call. EM is negatively related to FA and institutional investor coverage (Zhu Liu, 2014). More proof of FA value is the fact that capital markets rely on their opinions heavily (Fedyk, 2017).…”

“…The boost in the stock price is unjustified and temporary. If managers view EM as insufficient to prevent a shock, they can engage in expectations management; they can release negative information to cause FAs to lower earnings expectations (Zhu Liu, 2014). For example, business leaders can file an 8K to report monthly sales to show declines.…”

“…Xuan, Siew Hong, & Yinglei (2014) studied the words used by company leaders in public disclosures and found that an abnormally positive tone was indicative of future poor performance. Investors should be wary of excessively positive language; ordinary language carries more credibility (Zhu Liu, 2014). Lo, Ramos, and Rago (2016) show a positive relationship between complexity and unreadability of the MD&A section and EM.…”

“…On the one hand, many people believe that the FA provides an invaluable service to stakeholders. FAs are often the ones to ask tough questions of managers, demand accurate financial reporting, explain complicated business transactions, and expose accounting fraud (Zhu Liu, 2014). With one or more FAs snooping around, the presumption is that company managers will be more honest and transparent; they will avoid aggressive and creative accounting and will avoid decisions that favor short-term goals.…”