Earnings Management to Achieve Earnings Expectations Conditioned on Revenue Surprises: Testing by Multinomial Logit Model

This paper examines whether revenue surprises can affect management’s incentive to manipulate their reported earnings to meet or exceed analysts’ earnings forecasts. In particular, it tests whether managers would be more likely to manage earnings upward to achieve earnings expectations depending on the signal of revenue surprises. The empirical analysis using the multinomial logit model shows that managers have the higher likelihood of earnings management to have positive earnings surprises under positive revenue surprises. Further analysis considering all possible situations (R+E+, R+E-, R-E+, R-E-) provides evidence that firms have the strongest incentives to increase their earnings to exceed analysts’ earnings forecasts when they have negative unexpected revenue. These results are consistent with prior research that the major purpose of aligning earnings with market expectations is to avoid asymmetrical negative market responses associated with missing the expected earnings.