IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this article

Performance shocks and misreporting

Listed author(s):
  • Gerakos, Joseph
  • Kovrijnykh, Andrei
Registered author(s):

    We propose a parsimonious stochastic model of reported earnings that links misreporting to performance shocks. Our main analytical prediction is that misreporting leads to a negative second-order autocorrelation in the residuals from a regression of current earnings on lagged earnings. We also propose a stylized dynamic model of earnings manipulation and demonstrate that both earnings smoothing and target-beating considerations result in the same predictions of negative second-order autocorrelations. Empirically, we find that the distribution of this measure is asymmetric around zero with 27% of the firms having significantly negative estimates. Using this measure, we specify a methodology to estimate the intensity of misreporting and to create estimates of unmanipulated earnings. Our estimates of unmanipulated earnings are more correlated with contemporaneous returns and have higher volatility than reported earnings. With respect to economic magnitude, we find that, in absolute terms, median misreporting is 0.7% of total assets. Moreover, firms in our sample subject to SEC AAERs have significantly higher estimates of manipulation intensity.

    If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

    File URL: http://www.sciencedirect.com/science/article/pii/S0165410113000323
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

    Article provided by Elsevier in its journal Journal of Accounting and Economics.

    Volume (Year): 56 (2013)
    Issue (Month): 1 ()
    Pages: 57-72

    as
    in new window

    Handle: RePEc:eee:jaecon:v:56:y:2013:i:1:p:57-72
    DOI: 10.1016/j.jacceco.2013.04.001
    Contact details of provider: Web page: http://www.elsevier.com/locate/jae

    References listed on IDEAS
    Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

    as
    in new window


    1. Kormendi, Roger & Lipe, Robert, 1987. "Earnings Innovations, Earnings Persistence, and Stock Returns," The Journal of Business, University of Chicago Press, vol. 60(3), pages 323-345, July.
    2. Martin L. Weitzman, 1980. "The "Ratchet Principle" and Performance Incentives," Bell Journal of Economics, The RAND Corporation, vol. 11(1), pages 302-308, Spring.
    3. Josh Lerner, 2002. "150 Years of Patent Protection," American Economic Review, American Economic Association, vol. 92(2), pages 221-225, May.
    4. Paul Cashin & Hong Liang & C. John McDermott, 2000. "How Persistent Are Shocks to World Commodity Prices?," IMF Staff Papers, Palgrave Macmillan, vol. 47(2), pages 1-2.
    5. Fudenberg, Drew & Tirole, Jean, 1995. "A Theory of Income and Dividend Smoothing Based on Incumbency Rents," Journal of Political Economy, University of Chicago Press, vol. 103(1), pages 75-93, February.
    6. Brooks, LeRoy D & Buckmaster, Dale A, 1976. "Further Evidence on the Time Series Properties of Accounting Income," Journal of Finance, American Finance Association, vol. 31(5), pages 1359-1373, December.
    7. Fama, Eugene F & French, Kenneth R, 2000. "Forecasting Profitability and Earnings," The Journal of Business, University of Chicago Press, vol. 73(2), pages 161-175, April.
    8. George J. Stigler, 1963. "Capital and Rates of Return in Manufacturing Industries," NBER Books, National Bureau of Economic Research, Inc, number stig63-1.
    9. Ball, Ray & Kothari, S. P. & Robin, Ashok, 2000. "The effect of international institutional factors on properties of accounting earnings," Journal of Accounting and Economics, Elsevier, vol. 29(1), pages 1-51, February.
    10. Ball, Ray & Watts, Ross, 1972. "Some Time Series Properties of Accounting Income," Journal of Finance, American Finance Association, vol. 27(3), pages 663-681, June.
    11. Basu, Sudipta, 1997. "The conservatism principle and the asymmetric timeliness of earnings," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 3-37, December.
    12. Lang, Mark & Smith Raedy, Jana & Wilson, Wendy, 2006. "Earnings management and cross listing: Are reconciled earnings comparable to US earnings?," Journal of Accounting and Economics, Elsevier, vol. 42(1-2), pages 255-283, October.
    13. In-Mu Haw & Bingbing Hu & Lee-Seok Hwang & Woody Wu, 2004. "Ultimate Ownership, Income Management, and Legal and Extra-Legal Institutions," Journal of Accounting Research, Wiley Blackwell, vol. 42(2), pages 423-462, May.
    14. Dechow, Patricia M., 1994. "Accounting earnings and cash flows as measures of firm performance : The role of accounting accruals," Journal of Accounting and Economics, Elsevier, vol. 18(1), pages 3-42, July.
    15. George J. Stigler, 1963. "Introduction to "Capital and Rates of Return in Manufacturing Industries"," NBER Chapters,in: Capital and Rates of Return in Manufacturing Industries, pages 3-10 National Bureau of Economic Research, Inc.
    16. Christopher J. Neely & David E. Rapach, 2008. "Real interest rate persistence: evidence and implications," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 609-642.
    17. Dechow, Patricia M. & Kothari, S. P. & L. Watts, Ross, 1998. "The relation between earnings and cash flows," Journal of Accounting and Economics, Elsevier, vol. 25(2), pages 133-168, May.
    18. Collins, Daniel W. & Kothari, S. P., 1989. "An analysis of intertemporal and cross-sectional determinants of earnings response coefficients," Journal of Accounting and Economics, Elsevier, vol. 11(2-3), pages 143-181, July.
    19. Leuz, Christian & Nanda, Dhananjay & Wysocki, Peter D., 2003. "Earnings management and investor protection: an international comparison," Journal of Financial Economics, Elsevier, vol. 69(3), pages 505-527, September.
    20. George J. Stigler, 1963. "Errata Statement for "Capital and Rates of Return in Manufacturing Industries"," NBER Chapters,in: Capital and Rates of Return in Manufacturing Industries, pages 2-8 National Bureau of Economic Research, Inc.
    21. Schrand, Catherine M. & Zechman, Sarah L.C., 2012. "Executive overconfidence and the slippery slope to financial misreporting," Journal of Accounting and Economics, Elsevier, vol. 53(1), pages 311-329.
    22. Dichev, Ilia D. & Tang, Vicki Wei, 2009. "Earnings volatility and earnings predictability," Journal of Accounting and Economics, Elsevier, vol. 47(1-2), pages 160-181, March.
    23. Roychowdhury, Sugata & Watts, Ross L., 2007. "Asymmetric timeliness of earnings, market-to-book and conservatism in financial reporting," Journal of Accounting and Economics, Elsevier, vol. 44(1-2), pages 2-31, September.
    24. Beaver, William & Lambert, Richard & Morse, Dale, 1980. "The information content of security prices," Journal of Accounting and Economics, Elsevier, vol. 2(1), pages 3-28, March.
    25. repec:bla:joares:v:29:y:1991:i:2:p:193-228 is not listed on IDEAS
    26. Leone, Andrew J. & Rock, Steve, 2002. "Empirical tests of budget ratcheting and its effect on managers' discretionary accrual choices," Journal of Accounting and Economics, Elsevier, vol. 33(1), pages 43-67, February.
    27. Paul Hribar & D. Craig Nichols, 2007. "The Use of Unsigned Earnings Quality Measures in Tests of Earnings Management," Journal of Accounting Research, Wiley Blackwell, vol. 45(5), pages 1017-1053, December.
    28. repec:bla:joares:v:37:y:1999:i:1:p:57-81 is not listed on IDEAS
    29. Healy, Paul M., 1985. "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 85-107, April.
    30. Salamon, Gerald L & Smith, E Dan, 1977. "Additional Evidence on the Time Series Properties of Reported Earnings Per Share: Comment," Journal of Finance, American Finance Association, vol. 32(5), pages 1795-1801, December.
    31. repec:bla:joares:v:15:y:1977:i:2:p:226-244 is not listed on IDEAS
    32. Burgstahler, David & Dichev, Ilia, 1997. "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics, Elsevier, vol. 24(1), pages 99-126, December.
    Full references (including those not matched with items on IDEAS)

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:eee:jaecon:v:56:y:2013:i:1:p:57-72. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.