Do firms change earnings management behavior after receiving financial forecast warnings?

Abstract

This study investigates whether government-issued financial forecast warnings are associated with earnings management in Taiwan. In particular, we examine whether firms receiving warnings use different earnings management tools than firms without warnings. We find that firms that were warned prefer to use real activities manipulation than accrual-based earnings management to avoid potential litigation and penalties. In addition, we document that firms receiving warnings employed both accrual-based and real activities earnings management especially through over-production in response to the regulatory change from mandatory to voluntary disclosure in 2005. Our results suggest that while the government warning mechanism might constrain the forecasting firms from using accrual-based earnings management, the adoption of voluntary financial forecast disclosure did not necessarily prevent them from engaging in accrual-based manipulation.