Real and Accrual-Based Earnings Management to Achieve Industry-Average Profitability: Empirical Evidence from Japan

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This paper examines real and accrual-based earnings management to achieve industry-average profitability in Japanese firms. I focus on three types of real earnings management: sales manipulation, the reduction of discretionary expenditures, and overproduction. The results indicate that Japanese firms engage in income-increasing real and accrual-based earnings management to achieve industry-average profitability. Specifically, I find evidence of income-increasing real and accrual-based earnings management in firms that just meet or slightly beat industry-average profitability. The results also indicate that firms in more competitive industries engage in greater income-increasing earnings management to achieve industry-average profitability. The evidence in this paper is important because it suggests that managers engage in both real and accrual-based earnings management with an awareness of the profitability of competing firms in the same industry. Further, this paper shows the complementary relationship between two types of real (sales manipulation and overproduction) and accrual-based earnings management to achieve industry-average profitability. It also provides evidence of real and accrual-based earnings management to achieve industry-median profitability and industry-average forecast profitability.