Does benchmark-beating detect earnings management? Evidence from accounting irregularities

Abstract

We examine whether meeting or slightly beating an earnings benchmark (benchmark-beating) is (1) associated with accounting irregularities, an extreme and certain case of earnings management, (2) useful for detecting accounting irregularities both incremental and relative to discretionary accruals and to F-scores (Dechow, Ge, Larson, & Sloan, 2011), and (3) more useful for detecting opportunistic accounting irregularities, a more harmful form of earnings manipulation identified in Badertscher, Collins, and Lys (2012), than accounting irregularities in general. We identify an accounting irregularity sample where earnings are restated due to intentional misreporting and construct a control sample where earnings are not restated. We find that benchmark-beating is significantly positively associated with the probability of accounting irregularities after controlling for other determinants of accounting irregularities. In addition, benchmark-beating is useful for detecting accounting irregularities incremental to discretionary accruals and F-scores; benchmark-beating ties with and sometimes outperforms discretionary accruals for detecting accounting irregularities in a one-on-one horse race but is dominated by F-scores. Finally, benchmark-beating is more useful for detecting opportunistic accounting irregularities than accounting irregularities in general. Overall, we contribute to the literature by validating benchmark-beating as a proxy for earnings management.