Beat Earnings Benchmarks Research Articles

Non-IFRS earnings information in financial highlights of annual reports

Based on a sample of the top 200 Australian firms, we find that companies rely on non-IFRS earnings to supplement IFRS earnings in the highlights section of firms' annual reports. At the same time, firms are more likely to present non-IFRS earnings in the highlights section that beat earnings benchmarks, suggesting that they might be motivated to present their performance in a better light through non-IFRS earnings. We also show that non-IFRS earnings presented in the highlights section are more likely to be taken from the audited sections of the annual report, potentially indicating their credibility as key performance measures. Our findings add to the ongoing controversial debate on the informativeness of non-IFRS earnings with a specific focus on those reported in the highlights section of the annual report.

Is Audit Quality Higher When Audit Committees Report Strong Oversight?

SUMMARY This article provides a summary of recent research by Bratten, Causholli, and Sulcaj (2022), who examine whether issuers with audit committees who report strong oversight over the audit function have higher audit quality. Using a novel dataset from Audit Analytics that summarizes reported audit committee activities, Bratten et al. (2022) create a composite measure that captures the strength of the audit committee’s oversight of the audit process. The study uses several measures to capture audit quality, including audit fees, discretionary accruals, and propensity to meet or just beat earnings benchmarks. The authors show that, when issuers’ audit committees report activities consistent with being more active in overseeing the external auditor, issuers, on average, have better audit quality.

The Spillover Effect of Peer CEO Turnover on Real Earnings Management

ABSTRACT A growing literature provides evidence that peer considerations play a central role in shaping a firm’s behavior. This paper documents that the frequency of forced CEO turnovers by product market peer firms is negatively associated with a firm’s real earnings management. I find that the disciplinary role of forced CEO turnover explains the observed relation. These effects are stronger when firms are suspected to engage in real earnings management to meet or just beat earnings benchmarks. I find some evidence that peers’ forced CEO turnovers reveal a link between real earnings management and subsequent operating failure. Overall, my findings suggest that observing product market peers’ forced CEO turnovers provides an informative signal to discipline a firm’s real earnings management behavior. Data Availability: Data used in this study are available from public sources identified in the text. JEL Classifications: M41; M12.

Earnings expectations and the quality of financial services

Using complaint data filed by consumers with the Consumer Financial Protection Bureau against financial institutions, we show that banks receive, on average, 13.3% more customer complaints in the quarter immediately after they narrowly beat analysts’ earnings forecasts. The effect is mainly driven by banks’ attempts to reduce their non-interest expenses to beat earnings benchmarks. The relationship is stronger when bank CEOs receive a greater proportion of incentive-based compensation. Overall, our paper demonstrates how capital market incentives exacerbate shareholder–customer conflicts.

Do Firms Modify Investments in Tax Planning to Manage Earnings?

SYNOPSIS We examine whether suspect firms (that precisely meet or narrowly beat earnings benchmarks) decrease investments in tax planning to manage earnings; we refer to this strategy as the direct method of modifying discretionary tax fees to increase net income. We analyze investments in tax planning by suspect firms and find that most suspect firms increase earnings by curtailing these investments. Thus, suspect firms appear to prefer this direct method to the indirect method that prior studies have examined, in which firms increase investments in tax planning to reduce tax expense and, in turn, increase net income. We next examine the association between investments in tax planning by suspect firms and tax avoidance. Our findings suggest that suspect firms that increase investments in tax planning experience reductions in ETRs during the same period. In contrast, suspect firms that decrease investments in tax planning do not experience symmetric increases in ETRs.

Benchmark Beating and Earnings Manipulation in Nigerian Firms

Earnings management among firms remains a central focus for academics, auditors and regulatory bodies. Benchmark-motivated earnings management occurs when managers engage in opportunistic activities, including flexible use of accounting standards to misrepresent the information in a firm’s financial reports. Academic research has focused on how firms manage earnings to beat benchmarks, but the evidence regarding firms in emerging African stock markets is scarce and none is available for Nigeria. We applied both accruals quality and discretionary accruals models to detect whether firms that beat earnings benchmarks report earnings differently from others. Using 161 firms listed on the Nigerian Stock Exchange from 2002 to 2019, the study verifies how benchmark beaters manage earnings under the framework of two earnings thresholds – earnings (level) and positive earnings changes. Earnings persistence tests were carried out to verify whether benchmark beaters are consistent manipulators relative to non-beaters. The findings indicate that positive earnings benchmarks differ among the dichotomized groups. The evidence is not sufficient to validate that the change in earnings benchmarks motivates earnings discretions. However, the evidence may improve for larger samples. The study offers insights for informed decisions on the expectation of investment returns for investors, creditors, and other market partakers that require earnings information.

Employees’ perceptions and earnings benchmarks

PurposeEmployees, as internal stakeholders, not only play significant roles in a company’s operations but are also important users of a company’s financial information. However, prior accounting research to date has not explored whether employees incorporate a firm’s ability to meet earnings benchmarks in forming and revising their perceptions of firms. This study aims to focus on whether a firm’s ability to meet relevant earnings benchmarks impacts employees’ perceptions.Design/methodology/approachThe authors use employees’ perception scores from the 100 Best Companies to Work for from 1998 to 2015. The authors conduct an empirical study to examine the impact of beating earnings benchmarks on the perceptions of employees by estimating regression analyses. The dependent variable is employee perceptions of the firm. The variables of interest are the earnings growth and the analyst forecast benchmarks. The authors control for earnings performance and other determinants of employees’ perceptions.FindingsThe authors find that beating the earnings benchmarks is relevant for employees but has different impacts on the employees’ perceptions of firms. Specifically, both level and change analyses suggest that a firm’s ability to beat the earnings growth benchmark affects employees’ perceptions. However, the authors find no associations between employees’ perceptions and the analyst forecast benchmarks.Research limitations/implicationsThe authors recognize the amount of variation among the two groups’ perceptions from the binary variable creates an inherent limitation that the authors examine the best firms in terms of employee perceptions compared to the second-best firms. Therefore, the authors create another measure, EMPLOYEE_PERCEPTION2, which equals one if the firm’s ranking is within the top quartile and zero if the firm’s ranking is within the bottom quartile. This new variable increases the variation of employees’ perceptions in the sample to address the inherent limitation by allowing us to compare the best firms to the worst firms in the sample.Originality/valueThe study highlights the importance of beating earnings benchmarks for employees as a broader group of stakeholders. The study contributes to accounting benchmarks literature by exploring a different group of earnings benchmarks users. The authors also contribute to psychology studies by providing empirical evidence on the previously untested, intuitive prediction that employees’ views depend on a firm’s ability to meet relevant earnings benchmarks.

Internally generated intangible assets valuation: debate and literature review

This article contains a literature review around the issue of managerial discretion when deciding if and how much of an internally developed intangible asset’s development cost is to be capitalized. The interaction between earnings management and development cost capitalization is mentioned and the underlying factors, such as beating earnings benchmarks and meeting debt-covenants are discussed. In a nutshell, the trade-off between the additional informativeness offered to investors through signaling and the probability of managerial opportunistic behavior is debated. The results indicate that some degree of opportunism exists, intending mainly to beat analysts’ earnings forecasts. However, the market participants tend to identify such behaviors and thus adapt their equity price valuations. Also, the market value relevance varies depending on the entities’ origin, previous intangible project success or failure track record and intangible asset intensity.

Abnormal audit fees and audit quality: Australian evidence

We examine the association between abnormal audit fees and audit quality using Australian data. We find that audit quality, measured by auditors’ propensity to issue going concern opinions for financially distressed companies, discretionary accruals, and clients’ propensity to meet or beat earnings benchmarks, declines as positive abnormal audit fees increase in magnitude. Our findings support an economic bonding argument that positive abnormal audit fees reflect the extent of economic bonding between the auditor and the client. We also find that negative abnormal audit fees are negatively associated with the absolute value of discretionary accruals. Our findings suggest that academic researchers, practitioners, regulators, and others interested in assessing the effect of auditor remuneration on auditor independence and audit quality should be concerned with audit fees that are above a normal level rather than audit fees that are below a normal level of audit fees. JEL Classification: M42, M49

The spillover effect of shareholder activism: Evidence on firm reporting

This study examines the spillover effect of shareholder activism against target firms on financial reporting by non-target firms in portfolios held by the same activist shareholders. We find that firms that are not the target of institutional shareholders’ activism campaigns report more positive abnormal accruals. Cross-sectional tests indicate that the effect is more pronounced i) for firms that have more opportunities to engage in upward earnings management, or for firms with less effective alternative monitoring forces, and ii)when investors are more sensitive to good news. We also find that the effect is stronger when activist shareholders are more experienced, are waging more confrontational campaigns against target firms, and have larger holdings in non-target firms. We further find that non-target firms tend to report lower magnitude of asset write-downs, are more likely to restate financial statements and meet or beat earnings benchmarks, and exhibit a more optimistic tone in their 10-K/10-Q filings. Overall, our findings suggest that firms tend to window-dress their mandatory reporting to preempt possible shareholder activism against them.

Earnings management through financing activities: Evidence from early debt extinguishments

AbstractWe investigate whether early debt extinguishments, a financing activity, are used to manage earnings after the introduction of SFAS No. 145 in 2002. This standard changes the reporting rules of gains and losses from early debt extinguishments, which are now included in income from continuing operations. This shift in reporting rules provides firms with a potential opportunity to manage income from continuing operations, which is valued more by investors than below the line items. We hypothesize and find that gains from early debt extinguishments are positively associated with the magnitude of shortfall from earnings benchmarks and the propensity to meet or beat earnings benchmarks after the adoption of SFAS 145. Thus, our findings suggest unintended consequences of the SFAS No. 145, which may have implications for policy makers.

Overseeing the External Audit Function: Evidence from Audit Committees' Reported Activities

SUMMARYRecently, in response to calls for more transparency, many firms have begun reporting the activities undertaken by their audit committees in overseeing the work of the external auditor. We use a composite measure of audit committees' reported oversight activities for a sample of S&P 1500 firms and examine the extent to which these reported activities are associated with audit quality. We find that when firms' audit committees report exerting strong oversight, they have higher audit quality as proxied by audit fees, discretionary accruals, the likelihood of meeting or beating earnings benchmarks, and restatements. We also find that the market reacts positively to reports indicating strong oversight, consistent with perceptions of higher audit quality. This study extends prior literature on audit committees by introducing a new comprehensive measure of audit committees' reported oversight activities and sheds light on how these activities map into audit quality.JEL Classifications: M41; M42; G18.

MANDATORY JOINT AUDIT AND AUDIT QUALITY IN THE CONTEXT OF THE EUROPEAN BLUE CHIPS

This study investigates audit quality under joint and single audit regimes with a sample of large European firms. Both, the economic relevance of these companies, and the fact that the impact of joint audit on audit quality should be stronger when the audited company is a blue-chip firm motivate the study. If mandatory joint audit were positively associated with audit quality, French firms, under mandatory joint audit since 1966, should present higher audit quality compared to their European peers. The results do not indicate this to be the case. Specifically, similar levels of discretionary accruals are observed for French and other European firms. Furthermore, for the first time in the literature, evidence is reported indicating that French firms may even present lower audit quality than their European peers, when audit quality is measured by the likelihood of just beating earnings benchmarks. These results are expected to inform the ongoing debate in several countries about joint audits.

Real earnings management through syndicated lending

I examine whether banks manage syndicated loan originations to achieve financial reporting goals. Using a large sample of loans and relying on a within-quarter analysis, I find that publicly traded banks that narrowly beat earnings benchmarks initiate more loans in the last month of the fiscal quarter to book origination fees. Relative to otherwise similar loans, these loans are associated with front-end fees that are 4.2% higher but have credit spreads that are 3.3% lower, resulting in a net price discount of 2.5%. The findings are stronger for bigger banks, for lenders that are funding-constrained, and for banks whose managers’ pay is more sensitive to stock performance. Further, these loans underperform in terms of future defaults and rating downgrades. Finally, I find that while the hypothesized earnings management helps banks raise capital in the short term, it is costly in the longer term, as it is associated with lower capital and profitability ratios. Overall, I provide model-free evidence on banks’ real earnings management and the costs of this behavior.

Can financial analysts constrain real earnings management in emerging markets? Evidence from China

ABSTRACT We examine the effect of financial analysts on real earnings management in China. Our empirical results show a negative relationship between analyst coverage and real earnings management. This relationship exists within the full sample and sub-sample of firms meeting or beating earnings benchmarks. It survives tests to address endogeneity problems. We also find that real earnings management can impair companies’ profitability and analysts will revise their earnings forecasts downward for firms with aggressive real earnings management. Further research suggests that analysts can also curb accrual earnings management.

Interlocked Audit Partners and Board Directors: An Examination of Financial Reporting Quality

We examine the role of interlocking connections among board directors and external auditors on financial reporting quality. Following agency, social network, and resource dependence theoretical perspectives, we form different expectations according to directors' role on the board and in the financial reporting process. When such interlocks involve executive directors, we expect that they reduce auditors’ independence and decrease financial reporting quality. On the contrary, when audit committee non-executive directors are involved, such interlocks represent an effective channel to reinforce their co-operation and information sharing with auditors towards ensuring higher financial reporting quality. Investigating a sample of 794 companies listed in France, Germany, and the UK throughout 2009-2017, we find support for both our expectations. On the one hand, firms with executive-auditor interlocks have less reliable accruals and lower reporting conservatism. On the other hand, when experienced but not too busy, audit committee directors interlocked with auditors are associated with more reliable accruals and a lower likelihood of beating earnings benchmarks. We also show that these findings vary by country according to the strength of legal and governance traditions.

The Impact of CEO/CFO Outside Directorships on Auditor Selection and Audit Quality

We examine whether outside directorships of chief executive officer/chief financial officer (CEO/CFO) and resulting network ties to auditors affect auditor selection decisions and subsequent audit quality. The network ties arise when the CEO/CFO of a firm (home firm) serves as an outside director of another firm that hires an auditor (connected auditor). Using a sample of firms that switch auditors in the post-Sarbanes-Oxley Act period, we find that home firms are more likely to appoint connected auditors. We also find that home firms hiring connected auditors experience a significant decline in subsequent audit quality, compared to those hiring non-connected auditors. Specifically, the increases in the likelihood of misstatements, the magnitude of absolute discretionary accruals, and the propensity to meet or beat earnings benchmarks after home firms appoint connected auditors are significantly greater, compared to those for other firms switching to non-connected auditors. We further find that the decline in audit quality is more pronounced when the network is established at the local office level.

Understanding accounting discretion in China: An analysis of fair value reporting for investment property

This study sheds light on the discretionary accounting practices in China, the largest emerging market in the world. In particular, we focus on whether Chinese firms use discretion in investment property fair values to manage reported performance. We examine whether firms’ ex ante needs for accounting discretion affect their decisions to adopt fair value reporting for investment property and the ex post performance management by these fair value adopters. Our findings show that the voluntary adoption of fair value reporting for investment property in China remains low. However, the fair value option for investment property is significantly more likely to be chosen by firms with greater needs for accounting discretion. Consistent with the conjecture that firms choose the fair value model to manipulate reported earnings, we show that fair value adopters use the unrealized gains and losses associated with investment properties to smooth earnings and that these firms are also more likely to meet or beat earnings benchmarks after adoption. Overall, our findings indicate that the use of fair value reporting for investment property in the emerging Chinese market is driven by managerial opportunism.

Unconditional Conservatism and Subsequent Real Earnings Management

By focusing on the more pervasive unconditional conservatism, we provide fresh insights on how conservatism can be detrimental to financial reporting quality. We examine whether unconditionally conservative (UC) firms engage in more real earnings management (REM) in order to meet or beat earnings benchmarks (MBE). UC firms are expected to be prudent with persistently lower earnings. REM, on the contrary, is an expensive way, with long-term consequences, of manipulating earnings upwards. As expected, we find UC firms display higher discretionary expenses. However, UC firms suspected of engaging in MBE cut back on these expenses (REM) by 0.5 to 2 percent of earnings. Our results reveal differences in manipulation strategies adopted across different organizational forms: group-affiliated UC firms use this strategy opportunistically. Stronger monitoring decreases the level of REM at UC firms. Additionally, accruals manipulation and insider ownership affect an UC firm’s REM choices. Thus, decisions to manage real earnings and choose conservative reporting policies may be intertwined, adding to the debate about conservatism reducing reporting quality. Our findings identify opportunistic behaviour and real costs associated with being conservative which is counter-intuitive and a serious regulatory concern that standard setters and policy makers should consider.

Management Earnings Forecasts and the Cost of Debt

Prior studies have indicated that earnings are useful for bond market investors and that beating earnings benchmarks is related to a firm’s lower cost of debt. This study examines whether management earnings forecasts are related to a firm’s cost of debt. Our results indicate that (a) positive forecast innovations (i.e., forecasted increases in earnings) are related to a firm’s lower bond yield spread after controlling for the effect of other earnings benchmarks and (b) the negative association between positive forecast innovations and bond yield spread is weaker for firms with high default risk than for those with low default risk. The results suggest that management earnings forecasts are useful for investors in the Japanese bond market and are consistent with the findings in the equity market. However, the usefulness of management earnings forecasts in the bond market depends on a firm’s level of default risk. Our results suggest that bond investors discount the management earnings forecasts of firms with high default risk because such forecasts are more likely to have an optimistic bias.