Evidence on the Unconditional Preference for Accrual vs. Real Earnings Management

Abstract

Prior research shows that a greater level of cumulative accrual earnings management (AEM) over prior periods limits managers’ ability to use AEM in the current period and has suggested that this constraint on AEM is associated with greater use of real earnings management (REM). First, we confirm this result using new, more intuitive measures of cumulative AEM and cumulative REM. Second, we document that while constraints on the ability to use AEM are associated with a shift toward REM, constraints on the ability to use REM are not associated with a shift toward AEM. These results suggest that managers shift toward REM when necessary, but all else being equal, would prefer to use AEM. We also find that the Sarbanes-Oxley Act of 2002 weakened managers’ preference for AEM over REM.