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Earnings Management? Erroneous Inferences Based on Earnings Frequency Distributions

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  • CINDY DURTSCHI
  • PETER EASTON
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    Abstract

    ABSTRACT A vast literature following Hayn [1995] and Burgstahler and Dichev [1997] attributed the so-called "discontinuities" in earnings distributions around zero to earnings management. Despite recent evidence that these discontinuities are likely caused by other factors, researchers and teachers continue to point to the shapes of these distributions as evidence of earnings management. We provide three sets of further evidence that these discontinuities are likely caused by factors other than earnings management: (1) we provide, as an example, a detailed analysis of the severe effects of sample selection in a recent study; this study erroneously concludes that the shape of an earnings distribution is evidence of earnings management, (2) we provide a simple explanation for the shape of the earnings distribution that is most often cited as evidence of earnings management; the relation between earnings and prices differs with the magnitude and the sign of earnings, and (3) we provide further examples that support the main point of our paper; evidence beyond the mere shape of a distribution must be brought to bear before researchers can draw conclusions regarding the presence/absence of earnings management. Copyright (c), University of Chicago on behalf of the Accounting Research Center, 2009.

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    Bibliographic Info

    Article provided by Wiley Blackwell in its journal Journal of Accounting Research.

    Volume (Year): 47 (2009)
    Issue (Month): 5 (December)
    Pages: 1249-1281

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    Handle: RePEc:bla:joares:v:47:y:2009:i:5:p:1249-1281

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    Cited by:
    1. Yim, Andrew, 2013. "Mixture and Continuous 'Discontinuity' Hypotheses: An Earnings Management Model with Auditor-Required Adjustment," MPRA Paper 44702, University Library of Munich, Germany.
    2. Akinobu Shuto & Takuya Iwasaki, 2013. "The Effect of Institutional Factors on Discontinuities in Earnings Distribution: Public Versus Private Firms in Japan," Discussion Paper Series DP2013-32, Research Institute for Economics & Business Administration, Kobe University.
    3. Badertscher, Brad A. & Collins, Daniel W. & Lys, Thomas Z., 2012. "Discretionary accounting choices and the predictive ability of accruals with respect to future cash flows," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 330-352.
    4. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.

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