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Earnings management and the distribution of earnings relative to targets: UK evidence

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  • Pelham Gore
  • Peter Pope
  • Ashni Singh

Abstract

In this paper we provide new evidence on discontinuities in the distribution of reported earnings, using a large sample of UK firms. We examine the discontinuity phenomenon in the context of earnings management. We report that the empirical distribution of earnings before discretionary working capital accruals does not reflect the unusually high frequencies of small surpluses and unusually low frequencies of small deficits relative to targets found in the distribution of actual (reported) earnings, i.e. after discretionary working capital accruals. We find that discretionary working capital accruals have the effect of significantly increasing the frequencies of firms achieving earnings targets both overall and by small margins. Thus, we document an explicit link between working capital accruals-based earnings management and the discontinuities observed in the empirical distribution of earnings relative to targets. We also examine earnings management before and after the issuance of FRS 3 ‘Reporting Financial Performance’ and find evidence that FRS 3 altered earnings management strategies adopted by companies.

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  • Pelham Gore & Peter Pope & Ashni Singh, 2007. "Earnings management and the distribution of earnings relative to targets: UK evidence," Accounting and Business Research, Taylor & Francis Journals, vol. 37(2), pages 123-149.
    • Handle: RePEc:taf:acctbr:v:37:y:2007:i:2:p:123-149
    DOI: 10.1080/00014788.2007.9730065
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    Cited by:

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    6. Marques, Mário & Rodrigues, Lúcia Lima & Craig, Russell, 2011. "Earnings management induced by tax planning: The case of Portuguese private firms," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 20(2), pages 83-96.
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    18. Lucie Courteau & Jennifer L. Kao & Yao Tian, 2015. "Does Accrual Management Impair the Performance of Earnings-Based Valuation Models?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 42(1-2), pages 101-137, January.
    19. Chardonnens, Patrick & Fiechter, Peter & Wallmeier, Martin, 2022. "The disappearance of the zero-earnings discontinuity: SOX, dotcom boom or gradual decline?," Finance Research Letters, Elsevier, vol. 49(C).
    20. Rahman, Sheehan, 2019. "Discretionary tone, annual earnings and market returns: Evidence from UK Interim Management Statements," International Review of Financial Analysis, Elsevier, vol. 65(C).
    21. Chau Duong & Gioia Pescetto & Daniel Santamaria, 2014. "How value-glamour investors use financial information: UK evidence of investors' confirmation bias," The European Journal of Finance, Taylor & Francis Journals, vol. 20(6), pages 524-549, June.
    22. Lee, Cheng-Few & Sung, Hao-Chang, 2021. "Product market competition and real activities manipulation: Theory and implications," International Review of Economics & Finance, Elsevier, vol. 74(C), pages 192-205.

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