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The effect of real earnings management on the persistence and informativeness of earnings

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  • Li, Valerie

Abstract

This study investigates the effect of real earnings management on two important aspects of earnings quality: earnings persistence and its informativeness about future cash flows. I focus on real earnings management through the abnormal reduction in discretionary expenditures and investigate how this type of real earnings management affects earnings quality. Examining a large sample over a period of four decades, I find that the extent of real earnings management is negatively related to earnings persistence, and this effect is achieved largely through the negative effect of real earnings management on cash flows rather than on accruals. The less persistent current earnings as a result of real earnings management exhibit a weakened ability to predict future cash flows, suggesting a decreased informativeness of current earnings about future cash flows. Moreover, I find that the negative effect of the abnormal reduction in discretionary expenses on earnings persistence and its association with future cash flows from operations is more pronounced in the post-SOX period. Overall, the results suggest that real earnings management through the abnormal reduction in discretionary expenses is associated with deteriorated earnings quality.

Suggested Citation

  • Li, Valerie, 2019. "The effect of real earnings management on the persistence and informativeness of earnings," The British Accounting Review, Elsevier, vol. 51(4), pages 402-423.
    • Handle: RePEc:eee:bracre:v:51:y:2019:i:4:p:402-423
    DOI: 10.1016/j.bar.2019.02.005
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    4. Katarina Valaskova & Peter Adamko & Katarina Frajtova Michalikova & Jaroslav Macek, 2021. "Quo Vadis, earnings management? Analysis of manipulation determinants in Central European environment," Oeconomia Copernicana, Institute of Economic Research, vol. 12(3), pages 631-669, September.
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    6. Naser Makarem & Harjinder Singh & Nigar Sultana & Darren Henderson, 2023. "Policy uncertainty and real activities manipulation: evidence from Brexit," Review of Quantitative Finance and Accounting, Springer, vol. 61(4), pages 1415-1440, November.
    7. Mihai CARP & Iuliana Eugenia GEORGESCU, 2019. "The Influence of Audit Opinion on the Degree of Real Earnings Management. The Case of Romanian Listed Companies," The Audit Financiar journal, Chamber of Financial Auditors of Romania, vol. 17(156), pages 666-666.
    8. Ahsan Habib & Dinithi Ranasinghe & Julia Yonghua Wu & Pallab Kumar Biswas & Fawad Ahmad, 2022. "Real earnings management: A review of the international literature," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(4), pages 4279-4344, December.
    9. Lorenzo Simoni & Stefan Schaper & Christian Nielsen, 2022. "Business Model Disclosures, Market Values, and Earnings Persistence: Evidence From the UK," Abacus, Accounting Foundation, University of Sydney, vol. 58(1), pages 142-173, March.
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    More about this item

    Keywords

    Real earnings management; Abnormal reduction in discretionary expenditures; Earnings quality; Earnings persistence; Earnings informativeness;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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