Earnings Management to Avoid Losses with Positive, Negative, Large and Small Discretionary Accruals

Abstract

Most work studying earnings management has conjectured that firms with otherwise negative incomes use their accounting discretion to increase their reported incomes with positive discretionary accruals to just barely meet their zero earnings levels and have implemented research designs that treat all suspect EM firms as engaging in only this behavior. For example, Dechow et al. (2003) study whether small-loss firms using income-increasing discretionary accruals to report small profits explains the kink in the earnings distribution around the zero earnings level, but do not find support for that proposition. They conclude that one possible explanation (of several) is “that the earnings management story is more complex than the one we test.” Explaining, examining and documenting that more complex story is the contribution of our paper; the story that EM consists of positive, negative, large, and small exercises of discretionary accounting.