Discontinuities and Earnings Management: Evidence from Restatements Related to Securities Litigation

Abstract

Numerous studies infer earnings management from discontinuities around earnings benchmarks despite no direct evidence of an association. This study provides direct evidence relating discontinuities to earnings management by comparing the distribution of restated earnings to originally-reported earnings among firms that settle accounting-related securities litigation and restate earnings from the alleged GAAP violation period. Discontinuities are not present in the distribution of analyst forecast errors, earnings changes, and earnings levels using restated earnings but are present using originally-reported earnings. These shifts are caused by earnings management and cannot be explained by differences in scaling, sample selection, or other research design issues.