What Determines an Earnings String?*

Abstract

The purpose of this study is to understand better the role of fundamentals and earnings management in an earnings string. Using a large sample of firms with at least eight consecutive quarters of nonnegative changes in earnings, we find that accounting fundamentals exhibit increasing growth until about the fourth quarter prior to the string break. Further, we show that peaks in fundamentals predict a string break, reinforcing the importance of fundamentals for the continuation of a string. We only observe evidence of positive abnormal accruals when momentum in fundamentals slows. Analyses indicate that without earnings management, strings would not have continued. We also document that earnings management helps firms obtain a benefit in the form of higher returns. Finally, we show that earnings management is more consistent with managerial optimism rather than opportunism. Overall, results indicate that both fundamentals and earnings management are important for a string, with earnings management serving as an effective stop-gap measure when fundamental growth declines.