Earnings Thresholds Research Articles

Minijobs as stepping stones to regular employment: overall trends and the role of Midijob reforms

Minijobs are subsidized small jobs below a fixed earnings threshold. Since a reform in 2003, they are viewed as stepping stones to the first labor market. However, the Minijob subsidy generates a ‘Minijob trap’ that causes vast bunching at the Minijob earnings threshold. Therefore, Midijobs were designed to reduce this bunching and to eliminate the ‘Minijob trap’. Midijobs are employments that earn between the Minijob earnings threshold and the Midijob earnings threshold. In this range, Midijobs subsidize social insurance contributions on a sliding scale. This paper describes time trends in the propensity to leave Minijobs for regular employment and studies the role of Midijobs for transitions out of Minijobs. We find a strong increase in transitions from Minijobs to regular employment over time. However, there is no convincing evidence that Midijobs are connected to this development. Instead, behavioral changes and aggregate developments such as the business cycle and a booming labor market may have contributed to this development.

Take-up and labor supply responses to disability insurance earnings limits

In most disability insurance programs beneficiaries lose some or all of their benefits if they earn above an earnings threshold. While intended to screen out applicants with high remaining working capacity, earnings limits can also distort the labor supply of beneficiaries. We use a reduction in the earnings limit in Hungary to evaluate this trade-off and examine screening and labor supply responses. We find that the policy changed selection into the program modestly but reduced labor supply on the intensive margin significantly. These findings suggest that the earnings threshold should be higher.

How not to announce changes to the Immigration Rules

On 4 December, the Home Secretary unveiled a new package of measures to reduce immigration – a matter of great interest to faith communities, given that some of them depend fairly heavily on clergy and lay-workers from overseas to sustain their pastoral ministries. One of the elements in his statement to the Commons was a decision to ‘increase the skilled worker earnings threshold by a third to £38,700 from next spring, in line with the median full-time wage for those kinds of jobs’ and to raise the minimum income for family visas ‘to the same threshold as the minimum salary threshold for skilled workers, which is £38,700’.1

Earnings Management via Not-Wholly-Owned Subsidiaries

We investigate an unexplored mechanism of earnings management: income shifting from not-wholly-owned subsidiaries to help the parent company avoid losses at the expense of subsidiaries. Consolidated net income attributable to the parent company (i.e., net income) increases through this mechanism, as the parent company enjoys the full amount of the shifted earnings rather than sharing them with minority investors. We design an empirical model to directly estimate the amount of income shifted from subsidiaries to parent firms. Employing this measure, we find that firms opportunistically decrease earnings of their not-wholly-owned subsidiaries to manage net income upward to avoid losses. The results are stronger for firms with high noncontrolling ownership, firms with large subsidiaries, firms with strong influence over not-wholly-owned subsidiaries, and firms with a high level of related-party transactions. Our results are robust to alternative research designs, including controls for within-firm variations, alternative earnings thresholds, propensity score matching, and entropy balancing techniques. Our mechanism of earnings management is generalizable to other earnings management scenarios, such as share pledging. This paper was accepted by Brian Bushee, accounting. Funding: X. Zhang thanks the National Natural Science Foundation of China [Grant 72102243] for financial support. M. Luo thank the financial support from National Natural Science Foundation of China [Grant 71840011], and the Research Center for Digital Financial Assets at School of Economics and Management of Tsinghua University. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2022.03090 .

The economic-based earnings persistence of earnings momentum and its market implications

PurposePrior research on meeting or beating earnings thresholds documents that firms with earnings momentum are awarded with valuation premiums. However, it is unclear from this strand of literature why this is the case. Therefore, this study aims to investigate the effects of time-varying earnings persistence on earnings momentum and their pricing effects.Design/methodology/approachThis study exploits a firm that reports earnings momentum as research setting to examine whether earnings persistence is significantly higher for firms with consecutive earnings increases. In addition, it investigates a relation between earnings momentum and fundamentals-driven earnings persistence and estimates return associations of earnings momentum conditional on economic-based persistence of earnings.FindingsThe empirical evidence suggests that firms with earnings momentum reflect higher time-varying earnings persistence. It further reveals that longer duration of earnings momentum is associated with higher fundamentals-driven earnings persistence. More importantly, valuation premiums are exclusively assigned to earnings momentum determined by strong firm fundamentals, not momentum itself.Originality/valueThis study provides new empirical evidence that valuation premiums accrued to firms with earnings momentum are conditional on time-varying earnings persistence. The research implications are relevant to investors, regulators and auditors, as the results bring conclusions that earnings momentum reflects successful business models not poor accounting quality. This leads to a more complete view of earnings momentum and helps allocate resources when evaluating earnings-momentum firms.

Do Sin Firms Commit Accounting Sins?

Social norms deter socially responsible investors from investing in sin firms, i.e., firms that sell unethical products and profit from human vice. Existing literature documents that sin firms are less held by institutional investors and less followed by analysts, and this neglect effect leads to higher expected returns than in other firms. Our study explores the earnings management behavior of sin firms. Our empirical findings suggest that compared to others, sin firms are more likely to report small earrings surprises and small earnings increases, but less likely to report superior earnings. Sin firms’ earnings management behavior is exacerbated by lower non-transient institutional ownership, lower analyst coverage, and greater litigation risks. Additional analyses document that sin firms use both accrual-based management and real activity manipulation to report earnings that just meet earnings thresholds. The overall findings suggest that sin firms’ opportunistic behavior likely increases the information risks and contributes to the documented higher expected returns.

Do Managers Change Pension Plan Assumptions to Meet/Exceed Earnings Threshold? Korean Evidence

This study examines whether managers are likely to exercise discretion in determining pension plan actuarial assumptions to meet or exceed earnings targets. According to current accounting standards, managers can exercise broad discretion in setting actuarial assumptions under a defined benefit (DB) pension plan. Existing literature documents that managers can manage earnings upward by manipulating pension plan assumptions. Based on sample firms with DB pension plans from 2011 to 2018, our results reveal the followings. First, managers tend to manipulate pension assumptions optimistically when the unmanaged earnings miss the targets. Second, investors do not recognize the effect of changing assumptions on reported earnings and thus react favorably to the overstated earnings. Third, manipulating firms under-perform in the long run compared to the control group despite favorable short-term performance, which suggests accrual reversal and managerial attribute effects.

Earnings thresholds in South Africa listed enterprises: Manipulating research and developmental expenditures

Background: Research and developmental (RD) expenditure directly affects profits. Therefore, managers are likely to manipulate RD expenditure to meet earnings thresholds.Aim: This study investigates whether managers manipulate RD expenditure to meet earnings thresholds, while analysing whether the prospect theory explains this behaviour.Setting: The setting is 62 South African firms listed on the Johannesburg Stock Exchange (JSE) studied from 2011 to 2019.Method: We collected 379 annual samples from the SP Capital IQ database and applied the earnings distribution model to estimate the effect of the prospect theory on earnings management.Results: Most South African listed enterprises have earnings above zero, or have avoided reporting earnings in decline before earnings manipulation. Furthermore, the study’s findings reveal that enterprises that have earnings above zero, or have maintained their earnings in the previous period after manipulation, are risk lovers, whereas enterprises with earnings below zero, or lower than those in the previous period, are risk averters.Conclusion: South African listed enterprises do not have a tendency to manipulate RD expenditures to achieve earnings above zero or avoid reporting declining earnings. The prospect theory also fails to explain their behaviour.Contribution: This study is the first to analyse how the prospect theory explains the behaviour of earnings manipulation by using a sample of South African listed enterprises and thereby fills a research gap.

Managers’ rank & file employee coordination costs and real activities manipulation

We investigate the effect of managers' rank & file employee coordination costs on real activities manipulation (RAM). We identify exogenous variation in managers' rank & file employee coordination costs using the adoption of 99 wrongful dismissal laws across 47 U.S. states between 1970 and 1999. We first find that RAM declines when managers' rank & file employee coordination costs increase. We further document that managers’ rank & file employee coordination costs reduce decentralized RAM but affect neither centralized RAM nor centralized accrual-based earnings management, both of which are less likely to require rank & file employee coordination. Event-time tests corroborate and document the validity of the parallel trends assumption in our setting. Cross-sectional tests document predictable variation in our main result across firms and over time. Consistent with rank & file employee coordination costs constraining RAM, managers miss earnings thresholds more often after rank & file employee coordination costs increase. Our nuanced inferences inform the literature investigating factors that constrain RAM and the extent to which rank & file employees determine firm outcomes.

Earnings thresholds among the listed Brazilian enterprises: A strategy to avoid earnings loss or earnings decreased

Earnings thresholds among the listed Brazilian enterprises: A strategy to avoid earnings loss or earnings decreased

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.

Temporal evidence on threshold hierarchy based on accruals and real earnings management: Evidence from France and the US

Research Questions: Does the hierarchy of earnings thresholds differ between accounting systems? Does a temporal shift occur in the hierarchy of the earnings thresholds associated with earnings management? Motivation: A number of studies looked into the hierarchy of earnings thresholds based on the earnings distribution, capital market valuation, survey views, and discretionary accruals. Our study seeks to fill this gap by investigating the hierarchy of earnings thresholds based on real earnings management and by investigating if the hierarchy of earnings thresholds differs between accounting systems. Idea: This paper aims to examine the hierarchy of achieving certain earnings thresholds based on the magnitude of discretionary accruals and real earnings management under two different accounting models. Tools: Large samples of US and French firms for the period ranging from 2008 to 2018 are used. The relative extent of both discretionary accruals and real earnings management used to achieve three earnings thresholds is examined by regression analyses. Findings: Two hierarchies emerge from the US and French contexts. On the one hand, we find (1) avoiding earnings losses, (2) avoiding earnings decreases, and (3) avoiding negative earnings surprises in the US context. On the other hand, we find out (1) avoiding earnings losses, (2) avoiding negative earnings surprises, and (3) avoiding earnings decreases in the French context. An analysis of the real earnings management behavior of these firms indicates that they have used the significant real earnings management for the purpose of avoiding earnings decreases in both contexts. These hierarchies are reorganized over time. Contribution: Our paper contributes to the existing literature in several ways. First, the majorities of studies on earnings management examine and validate opportunistic incentives, whereas our results validate incentives with reference to the signaling theory. Second, our findings are of interest to investors, auditors, regulators and academics with respect to the financial statement analysis, accounting earnings quality, and financial reporting. Research limitations: This study is subject to measurement error which is a common limitation in the earnings management literature.

Evaluating the policy effect of adjustment of the minimum and maximum levels of Pensionable Earnings Thresholds

본 연구는 기준소득월액 상·하한 조정이 국민연금의 급여 및 재정에 미치는 영향을 검토하는 데 목적을 두었다. 이를 위해, 국내외 다양한 지표와의 비교를 통해 현행 상·하한 기준의 추가 조정 필요성을 도출하고, 조정안별 정책효과를 분석하였다. 주요 연구결과를 살펴보면 다음과 같다. 먼저 그동안의 제도개선을 통해 평균소득 대비 상·하한액 수준이나, 상·하한 구간 가입자 비중이 과거에 비해 안정화 추세에 접어든 것으로 나타났다. 하지만 여전히 국내외 타 연금제도에 비해 상·하한액의 절대 수준이 낮고, 해당 구간 가입자 비중이 과대 또는 과소한 편이며, 이로 인해 국민연금의 방빈 및 소득대체 기능이 저하될 가능성이 있는 것도 사실이다. 둘째, 상·하한 조정 시 국민연금 가입자의 급여수준이 전반적으로 상향되는 것으로 나타났다. 이는 무엇보다 기준소득월액 인상으로 인해, 상·하한 구간 가입자의 균등급여(A급여) 및 비례급여(B급여)가 모두 증액된 데 기인한 것이라고 할 수 있다. 셋째, 상·하한 조정으로 인한 재정효과는 적어도 현 추계기간(~2088년) 내에서는 크게 부담스럽지 않은 수준으로 나타났다. 다만, 상·하한 조정이 급여지출로 이어지기까지 시차가 존재한다는 점을 고려하면, 그 이후 시점에는 부담이 늘어날 개연성도 있다. 이상의 연구결과는 향후 기준소득월액 개편방안 마련 시 유용한 참고자료가 될 수 있을 것으로 기대한다.

Product Life Cycle Lengths and Real Activities Management

We examine how short product life cycle lengths constrain real activities management among a group of manufacturing firms. Companies with short-cycle products face fast product obsolescence and constant pressure to develop and market new products. Fast product obsolescence increases the cost of overproduction, while constant pressure for new product development increases the cost of opportunistic spending cuts. We predict and find evidence that in general, short-cycle firms do not beat earnings thresholds through overproduction and discretionary spending cuts as extensively as long-cycle firms do. However, since the Sarbanes-Oxley Act came into effect, short-cycle firms have increasingly overproduced, and there is no longer a difference in overproduction between short- and long-cycle firms. Moreover, the presence of major customers attenuates the relationship between product life cycle lengths and real activities management, while a large market share and high fixed-assets intensity both accentuate the relationship. Finally, short-cycle firms are also less likely to use LIFO (last-in, first out) liquidation to inflate earnings than long-cycle firms.

Earnings Thresholds in Chinese High-Tech Enterprises: The Role of Corporate Income Tax Incentives

To encourage corporate investment in innovation or R & D and to foster innovative firms, the Chinese government established standards for the certification of high-tech enterprises in 2008. Business entities that meet these standards are entitled to tax deductions. The criteria include the proportion of R & D expenses to sales exceeding a certain percentage in the prior 3 years among different sales in the current year. The purpose of this paper is to investigate whether this criteria influence management’s preferences for an earnings threshold. This study collects data from 2008 to 2018 from the CSMAR database. All of the 1932 listed high-tech enterprises are included, with a total of 7547 samples. The results indicate: sales of 50 - 200 million yuan in the current year and a proportion of R & D expenses to sales in the prior 3 years before manipulating sales or R & D expense; sales above 200 million yuan in the current year, and that most of these firms’ proportion of R & D expenses to sales before manipulating sales or R & D expenses achieved the required ratio to qualify as a high-tech enterprise. Specifically, the results suggest that 88.83% of the listed high-tech enterprises in China focus on R & D activities or innovations, regardless of whether they qualify as a high-tech enterprise according to the Chinese government. However, a few of the samples’ proportion of R & D expenses to sales are below 3% in the prior 3 years when their sales exceed 200 million yuan in the current year before the manipulation of sales or R & D expenses. Of these firms, half have a proportion of R & D expenses to sales exceeding 3% after the manipulation of sales or R & D expenses. Overall, the results also support the presence of prospect theory in Chinese-listed high-tech enterprises, because mangers tend manipulate earnings by adjusting sales or R & D expenses to obtain tax benefits.

Quarterly earnings thresholds: Making the case for prior quarter earnings

AbstractWe provide evidence that the prior quarter earnings number is an important and informative benchmark that is relatively unexplored in the accounting literature. Our analyses suggest that managers appear to avoid negative earnings changes relative to the prior quarter. Moreover, we find that even after controlling for the information contained in other frequently used benchmarks (i.e., analysts’ forecasts and earnings from the same quarter of the prior year), changes over the prior quarter's earnings are associated with stock returns. We find that this result is stronger post‐Regulation FD and XBRL, perhaps as a result of the improved information environment. We also find that the informativeness of prior quarter earnings is greater for firms with less volatile earnings and that meeting‐or‐beating prior quarter earnings are associated with future performance.

Market Reaction to Abnormal Inventory Growth: Evidence for Managerial Decision-Making

ABSTRACT Prior research demonstrates that manufacturing firms increase production (relative to sales) to transfer fixed costs from cost of goods sold (COGS) to inventory accounts, thereby increasing income to reach or surpass earnings thresholds. We examine how the market reacts to this earnings management strategy. We find that investors respond positively to inventory growth based on an expectation of increased future sales; however, this signal is weaker for inventory manipulators. Further, the market premium from meeting or beating analyst earnings forecasts by manipulating inventory is smaller than the premium for achieving this threshold absent inventory manipulation or through accrual manipulation. Finally, we examine firms considered to be “serial” inventory manipulators, finding that the market consistently discounts earnings beats for these firms, suggesting that inventory manipulation erodes investor confidence in firms' earnings. Collectively, our results provide new insights into a challenge facing operations managers and finance managers in manufacturing firms.

Private Lenders' Use of Analyst Earnings Forecasts When Establishing Debt Covenant Thresholds

ABSTRACT We examine whether lenders use analyst forecasts of the borrower's earnings as inputs when establishing covenant thresholds in private debt contracts. We find that, among debt contracts that include an earnings covenant, earnings thresholds are set closer to analyst forecasts when analysts have historically issued more accurate earnings forecasts. These results are robust to firm fixed effects and an instrumental variable approach. Further, we find that, following a plausibly exogenous decline in the availability of analyst earnings forecasts, debt contracts are less likely to include earnings covenants. Our evidence is consistent with lenders using analyst earnings forecasts as an input when establishing debt covenant thresholds and suggests sell-side analysts play a role in debt contracting.

Meeting Dividend Thresholds Through Earnings Management of Listed Companies in South Africa

Dividend distribution influences corporate operating decisions, and the prior year’s dividends represent an earnings threshold. The purpose of this study was to clarify perceptions regarding the manipulation of income toward a desired earnings goal (i.e., dividend threshold). In this study, data from 2011 to 2019 were collected from the S&P Capital IQ database. A regression model was adopted to analyze the manipulation of income toward a dividend threshold (i.e., desired earnings goal) among South Africa’s listed industry. Moreover, the behavior of managers of listed South African firms tended to meet or exceed dividend thresholds by manipulating earnings, which is consistent with signal theory, prospect theory and agency theory. Keywords: Dividend thresholds, Earnings management, South Africa, Signal theory, Prospect theory.

Managing Earnings to Appear Truthful: The Effect of Public Scrutiny on Exactly Meeting a Threshold

The past two decades have not eliminated managers’ willingness to manage earnings to meet and beat earnings thresholds, but have increased investors’ skepticism of earnings that exactly meet those thresholds, providing perverse incentives to not meet earnings expectations exactly. Using a low-external-context experiment, we find that managers avoid exactly meeting a benchmark, even when they must alter true earnings and incur a monetary cost to do so. We manipulate the effect of intensified scrutiny of managers and find that when earnings exactly meet a benchmark, managers are more likely to misreport earnings when they report under high public scrutiny. This is particularly the case for managers who are sensitive to others’ perceptions (and thus low on the Dark Triad scale). Further, we show that this misreporting increases managers’ belief that the market will accept their reports, consistent with managers misreporting for self-presentational goals. Thus, we examine a new incentive to manage earnings: misreporting to appear truthful. These results help explain otherwise undetectable behavior around earnings benchmarks and are important as managers are increasingly scrutinized by critical media, activists, and political oversight bodies, and as they face skepticism via more intimate forms of disclosure and communication, such as social media.