Earnings Management and Analyst Following: A Simultaneous Equations Analysis

Hong, Yongtao; Huseynov, Fariz; Zhang, Wei

doi:10.2139/ssrn.2139559

Cited by 11 publications

(19 citation statements)

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“…By showing that analysts lower future earnings forecasts and stock recommendations of the firms that show signs of RAM, this study suggests that analysts understand the negative effect of RAM on firms' future performance and respond accordingly. This finding can be interpreted as a reason for the negative association between analyst following and real earnings management presented in previous studies (Hong et al, 2014). In this sense, our study extends Yu (2008) and Hong et al (2014).…”

Section: Introductionsupporting

confidence: 84%

“…Prior RAM studies document the negative association between RAM and firms' future operating performance (Cohen and Zarowin, 2010;Christensen et al, 2016). Another stream of research presents evidence showing the monitoring role of security analysts who prevent management from engaging in either accrual or real activities management (Yu, 2008;Hong et al, 2014). None of the previous studies, however, clearly, examines whether analysts have the ability to detect RAM.…”

Section: Introductionmentioning

confidence: 99%

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Analysts’ reactions to firms’ real activities management

Chung

2019

RAF

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Purpose Firms’ real activities management (RAM) can have a more detrimental effect on firms’ future performance than accrual earnings management. This paper aims to examine whether analysts, who play an important role as information intermediaries, understand the negative effect of RAM on firms’ future performance and respond to it accordingly. Design/methodology/approach The authors investigate whether analysts lower their earnings forecasts and stock recommendations of the firms with RAM. The authors measure RAM by examining firms’ abnormal decreases in discretionary expenses, abnormal increases in production and abnormal decreases in cash flow from operations following prior literature. Findings The authors find that after controlling for earnings surprises and other important firm characteristics, analysts lower their forecasts of future annual earnings and stock recommendations of the firms that show signs of RAM. Research limitations/implications First, as in other RAM studies, the results in this study are subject to measurement errors inherent in the estimation of RAM (i.e. abnormal production costs, abnormal CFO and abnormal discretionary expenditures). Second, we include only firm-year observations that barely make positive income in our samples following the previous study. This sample selection criterion helps increase the power of the test by examining the “suspect firms group,” which are more likely to engage in earnings management. However, one can challenge that our findings on the association between RAM and analysts’ reactions could be only case-specific and cannot be generalized. Practical implications This study contributes to the literature on earnings management and especially on RAM. Specifically, none of the previous studies clearly examines whether analysts understand the negative impact of RAM on firms’ future performance and respond accordingly, although there are studies showing the negative association between RAM and firms’ future operating performance and studies showing the negative association between analysts following and RAM. Thus, filling the gap, this study provides a specific reason for the negative association between the analyst following and real earnings management presented in previous studies. Social implications The findings will be of interest to regulators, who are concerned about the potential negative consequences in which tighter accounting standards can result. For example, Ewert and Wagenhofer (2005) theoretically demonstrate that tighter accounting standards can prompt more RAM instead of accounting earnings management. The study provides important evidence supporting that such suboptimal operating activities are closely watched by analysts and are potentially penalized by the market. If the market is able to detect RAM and allocate fewer resources to the firms that engage in it, then the concerns associated with the substitution effect between accrual-based earnings management and RAM can be diminished. Originality/value Prior research suggests that tighter accounting regulations (e.g. the Sarbanes-Oxley Act) prompt more RAM than accounting earnings management. The study provides evidence supporting that such suboptimal operating activities are closely watched by analysts and are potentially penalized by the market.

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Section: Introductionsupporting

confidence: 84%

Section: Introductionmentioning

confidence: 99%

Analysts’ reactions to firms’ real activities management

Chung

2019

RAF

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“…13 In addition, Hong et al (2012) indicate that both AEM and REM are significantly reduced by analyst following. Their results indicate that AEM and REM are restrained because analysts scrutinize and monitor firm activities.…”

Section: Analyst Followingmentioning

confidence: 98%

Accrual-based and real earnings management: An international comparison for investor protection

Enomoto

Kimura

Yamaguchi

2015

Journal of Contemporary Accounting & Economics

194

140

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This paper examines the differences in accrual-based and real earnings management across countries from the perspective of investor protection. Following prior research (Leuz et al., 2003), we hypothesize that accrual-based earnings management is more constrained by strict discipline in countries with stronger investor protection. For real earnings management in countries with stronger investor protection, we have two hypotheses. One is that real earnings management is more often implemented to substitute for accrual-based earnings management. The other is that real earnings management is less often implemented, as with accrual-based earnings management. Our examination uses data from 222,513 firm-year observations drawn from 38 countries covering 1991 to 2010. The results show that managers in countries with stronger investor protection tend to engage in real earnings management instead of accrual-based earnings management. We also find that real earnings management is constrained by analyst following. Our results are not affected by the control of audit quality or the calculation method used for earnings management measures according to country and year.Highlights ・Earnings management is affected by investor protection in each country.・Accrual-based earnings management decreases under stronger investor protection.・Real earnings management increases under stronger investor protection.・Real earnings management decreases with analyst following. JEL Classification: G34 K22 M41 P4 G38

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“…These theoretical arguments are supported by empirical evidence. In particular, regarding the attention of professional analysts, Hong, Huseynov, and Zhang (2014) show that analysts' decision on whether to start following a firm is not random and may depend on the firm's decisions such as the quality of disclosures. We will test whether analysts also react to cheap talk.…”

Section: Related Literaturementioning

confidence: 99%

Managerial incentives for attracting attention

Gutiérrez

Papiashvili²,

Tribó

et al. 2019

Euro Fin Management

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This paper studies the mechanisms which motivate managers to engage in cheap talk and attract the market's attention in a credible way. We consider stock split announcements, voluntary earnings forecasts, and press releases issued by firms to the media as proxies for managerial cheap talk. We show that: (a) managerial performance‐related pay contracts incentivize executives to attract attention; (b) analysts increase their coverage of firms following cheap talk; and (c) chief executive officers are punished for attracting attention when market prices do not increase following cheap talk. The results are stronger for firms which are most in need of attention.

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Earnings Management and Analyst Following: A Simultaneous Equations Analysis

Cited by 11 publications

References 0 publications

Analysts’ reactions to firms’ real activities management

Analysts’ reactions to firms’ real activities management

Accrual-based and real earnings management: An international comparison for investor protection

Managerial incentives for attracting attention

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