Meeting Earnings Benchmarks via Real Activities Manipulation: Debt Market Effects

Abstract

We investigate the cost of debt effects for firms that manage earnings per share (EPS) through abnormal share repurchases. Although prior research finds a significant cost of debt decrease for firms that meet earnings benchmarks, our results suggest that firms using the abnormal share repurchase strategy realize no cost of debt decrease associated with meeting earnings benchmarks. We find some evidence of a smaller decrease in cost of debt associated with measures of abnormal decreases in cash flows but weak evidence for measures that are cash flow increasing. We also find that the effect of using abnormal stock repurchases to meet earnings benchmarks leads to smaller reductions in the cost of debt when compared with the cost reduction when earnings benchmarks are met through accruals management. This study extends prior literature regarding the effects on the cost of debt through alternative strategies to meet earnings benchmarks and will be of interest to managers as they consider the impact of their managerial decisions.

Do Shariah-compliant Companies Engage Lesser Earnings Management Behaviour?

“…Real activities earnings management is defined as management actions that deviate from normal business practices and are undertaken for purposes of meeting certain earnings i.e., a deviation from companies' normal operational activities (Roychowdhury, 2006). Following recent researchers, this study also uses Roychowdhury's model which comprises four measures to detect real activities earnings management (e.g., Amoah, Anderson, Bonaparte, & Muzorewa, 2017;Hinkel & Hoffman, 2017;Wardhani & Anggraenni, 2017). They are: (i) operating cash flows, (ii) production costs, (iii) expenses, and (iv) combined measures of real activities manipulation (refer Appendix B for details).…”

Earnings thresholds among the listed Brazilian enterprises: A strategy to avoid earnings loss or earnings decreased

“…However, such an approach is still adopted to prevent earnings from falling below the expected thresholds and generating negative investor feedback. Hinkel and Hoffman (2020) show that firms that use the share repurchase strategy to meet earnings benchmarks lead to smaller reductions in the cost of debt. Fogel-Yaari and Ronen (2020) show that meeting or beating expectations/thresholds is good news because it signals that the firm will also meet or beat expectations in the future and explains the richness of the menu of reporting strategies ("taking a bath," "cookie-jar reserves," or marginal threshold beating).…”

“…Investors and creditors value performance. Therefore, enterprise managers experience earnings pressure and may manipulate earnings through business activities (Phan et al, 2017;Jeong & Choi, 2019;Kałdoński & Jewartowski, 2020;Liu et al, 2021) to avoid earnings decreases (Byun & Roland, 2022) or to meet analysts' earnings forecasts (Gastón & Jarne, 2021), or engage in earnings management such as avoiding earnings losses (Hinkel & Hoffman, 2020). Bartov et al (2002) and Brown and Caylor (2005) demonstrate that managers tend to manipulate earnings to meet a specific threshold and prevent negative investor feedback from decreasing share prices, which provides a signal of future growth to outsiders.…”