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Why Are Earnings Kinky? An Examination of the Earnings Management Explanation

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  • Patricia M. Dechow

    (University of Michigan Business School)

  • Scott A. Richardson

    (University of Pennsylvania)

  • Irem Tuna

    (University of Pennsylvania)

Abstract

Prior research has documented a “kink” in the earnings distribution: too few firms report small losses, too many firms report small profits. We investigate whether boosting of discretionary accruals to report a small profit is a reasonable explanation for this “kink.” Overall, we are unable to confirm that boosting of discretionary accruals is the key driver of the kink. We caution the use of the ratio of small profit firms to small loss firms as a measure of earnings management. We investigate and discuss a number of alternative explanations for the kink.

Suggested Citation

  • Patricia M. Dechow & Scott A. Richardson & Irem Tuna, 2003. "Why Are Earnings Kinky? An Examination of the Earnings Management Explanation," Review of Accounting Studies, Springer, vol. 8(2), pages 355-384, June.
    • Handle: RePEc:spr:reaccs:v:8:y:2003:i:2:d:10.1023_a:1024481916719
    DOI: 10.1023/A:1024481916719
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    References listed on IDEAS

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    1. Lawrence D. Brown, 2001. "A Temporal Analysis of Earnings Surprises: Profits versus Losses," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 39(2), pages 221-241, September.
    2. Patricia M. Dechow & Richard G. Sloan & Amy P. Sweeney, 1996. "Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC," Contemporary Accounting Research, John Wiley & Sons, vol. 13(1), pages 1-36, March.
    3. Jones, Jj, 1991. "Earnings Management During Import Relief Investigations," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 29(2), pages 193-228.
    4. Abarbanell, Jeffery & Lehavy, Reuven, 2003. "Biased forecasts or biased earnings? The role of reported earnings in explaining apparent bias and over/underreaction in analysts' earnings forecasts," Journal of Accounting and Economics, Elsevier, vol. 36(1-3), pages 105-146, December.
    5. DeFond, Mark L. & Subramanyam, K. R., 1998. "Auditor changes and discretionary accruals," Journal of Accounting and Economics, Elsevier, vol. 25(1), pages 35-67, February.
    6. Paul Hribar & Daniel W. Collins, 2002. "Errors in Estimating Accruals: Implications for Empirical Research," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 40(1), pages 105-134, March.
    7. Mark T. Bradshaw & Richard G. Sloan, 2002. "GAAP versus The Street: An Empirical Assessment of Two Alternative Definitions of Earnings," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 40(1), pages 41-66, March.
    8. Patricia M. Fairfield & Scott Whisenant & Teri Lombardi Yohn, 2003. "The Differential Persistence of Accruals and Cash Flows for Future Operating Income versus Future Profitability," Review of Accounting Studies, Springer, vol. 8(2), pages 221-243, June.
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    Cited by:

    1. Richard Frankel & William J. Mayew & Yan Sun, 2010. "Do pennies matter? Investor relations consequences of small negative earnings surprises," Review of Accounting Studies, Springer, vol. 15(1), pages 220-242, March.
    2. Henock Louis & Dahlia Robinson & Andrew Sbaraglia, 2008. "An integrated analysis of the association between accrual disclosure and the abnormal accrual anomaly," Review of Accounting Studies, Springer, vol. 13(1), pages 23-54, March.
    3. Philippe Jorion & Charles Shi & Sanjian Zhang, 2009. "Tightening credit standards: the role of accounting quality," Review of Accounting Studies, Springer, vol. 14(1), pages 123-160, March.
    4. Sarah McVay & Venky Nagar & Vicki Wei Tang, 2006. "Trading incentives to meet the analyst forecast," Review of Accounting Studies, Springer, vol. 11(4), pages 575-598, December.
    5. William Ciconte & Marcus Kirk & Jennifer Wu Tucker, 2014. "Does the midpoint of range earnings forecasts represent managers’ expectations?," Review of Accounting Studies, Springer, vol. 19(2), pages 628-660, June.
    6. Baruch Lev & Stephen G. Ryan & Min Wu, 2008. "Rewriting earnings history," Review of Accounting Studies, Springer, vol. 13(4), pages 419-451, December.
    7. Jiaoliang Jiang & Hengmiao Bao & Shijie Yang, 2025. "The effect of shareholder pressure on stakeholder interests: Evidence from corporate tax avoidance," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 30(3), pages 2492-2513, July.
    8. Lynn Rees & Wayne Thomas, 2010. "The stock price effects of changes in dispersion of investor beliefs during earnings announcements," Review of Accounting Studies, Springer, vol. 15(1), pages 1-31, March.
    9. William H. Beaver & Maureen F. McNichols & Karen K. Nelson, 2007. "An alternative interpretation of the discontinuity in earnings distributions," Review of Accounting Studies, Springer, vol. 12(4), pages 525-556, December.

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