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Determinants of management's preferences for an earnings threshold

Author

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  • Sherry Fang Li

Abstract

Purpose - Previous research has provided mixed evidence on the relative importance of three earnings thresholds that managers seek to achieve: avoiding losses, avoiding earnings declines and avoiding negative earnings surprises. The purpose of this paper is to investigate whether firm-specific factors influence management's preferences for an earnings threshold. Design/methodology/approach - Logit models are estimated to explore the relationships between firm-characteristics and management's perceptions of the relative importance of each threshold. Findings - This paper finds that: large firms, firms with high growth prospects and firms with high trading volume are more concerned with avoiding negative earnings surprises, while small firms, firms with low growth prospects and firms with low trading volume are more prone to avoid earnings declines and losses; for firms with high analyst forecast accuracy (relative to a random walk model forecast), avoiding negative earnings surprises is more important than avoiding earnings declines and losses; and firms with low analyst forecast dispersion focus more on avoiding negative earnings surprises and losses, while firms with high analyst forecast dispersion focus more on avoiding earnings declines. Overall, this paper shows that firm characteristics do affect management's perceptions of the relative importance of each threshold. Originality/value - This study recognizes the cross-sectional differences in the earnings threshold hierarchy. The results suggest that regulators and practitioners should focus on different thresholds for different types of firms when investigating the mechanisms used to achieve the thresholds.

Suggested Citation

  • Sherry Fang Li, 2010. "Determinants of management's preferences for an earnings threshold," Review of Accounting and Finance, Emerald Group Publishing, vol. 9(1), pages 33-49, February.
  • Handle: RePEc:eme:rafpps:v:9:y:2010:i:1:p:33-49
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    References listed on IDEAS

    as
    1. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, pages 3-73.
    2. Burgstahler, David & Dichev, Ilia, 1997. "Earnings management to avoid earnings decreases and losses," Journal of Accounting and Economics, Elsevier, pages 99-126.
    3. repec:bla:joares:v:25:y:1987:i:1:p:49-67 is not listed on IDEAS
    4. Degeorge, Francois & Patel, Jayendu & Zeckhauser, Richard, 1999. "Earnings Management to Exceed Thresholds," The Journal of Business, University of Chicago Press, vol. 72(1), pages 1-33, January.
    5. repec:bla:joares:v:35:y:1997:i:2:p:157-179 is not listed on IDEAS
    6. Mark T. Bradshaw & Scott A. Richardson & Richard G. Sloan, 2001. "Do Analysts and Auditors Use Information in Accruals?," Journal of Accounting Research, Wiley Blackwell, vol. 39(1), pages 45-74, June.
    7. Graham, John R. & Harvey, Campbell R. & Rajgopal, Shiva, 2005. "The economic implications of corporate financial reporting," Journal of Accounting and Economics, Elsevier, pages 3-73.
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