۱- Introduction

۲- Prior literature and hypotheses development

۳- Sample and research design

۴- Empirical results

۵- Additional analysis

۶- Conclusion

References

Abstract

Prior studies provide consistent evidence that firms use a combination of management forecast guidance, accrual earning management (AEM), and real activity earnings management (REM) to meet or beat analyst expectations (MBE). While recent evidence (e.g. Kross, Ro, & Suk, 2011) suggests that management forecast guidance is a less effective MBE strategy for firms with longer strings of MBE, less is known about the use of AEM and REM to manage MBE strings as the string lengthens. Since managements’ incentives and actions taken to maintain earnings strings may differ as the string lengthens and becomes more difficult to sustain, we examine the extent to which managers use AEM and REM to MBE as the string grows longer. We find evidence that while firms with shorter MBE strings appear more likely to use income increasing AEM to sustain their MBE strings, the use of income increasing AEM decreases for longer MBE strings. Further, we document that firms with longer MBE strings use more income increasing REM to avoid breaking the MBE string. Collectively, our results suggest that researchers investigating firms’ earnings management choices to sustain MBE strings should control for the length of the MBE string in their research design.

Introduction

Analysts’ forecasts serve as an important proxy for the market’s expectation of earnings and are a key benchmark for managers (Degeorge, Patel, & Zeckhauser, 1999; Graham & Harvey, 2005). The extant literature has documented significant benefits accruing to firms that meet or beat analyst expectations (hereafter “MBE”). For example, MBE firms earn higher equity return premiums (Bartov, Givoly, & Hayn, 2002; Brown & Caylor, 2005; Doyle, Lundholm, & Soliman, 2006), are perceived by investors to be less risky (Kasznik & McNichols, 2002), are more likely to receive bond rating increases and smaller initial bond yield spreads (Jiang, 2008), and have lower cost of capital (Brown, Hillegeist, & Lo, 2009; Duarte, Han, Harford, & Young, 2008).1 Further, the prior literature suggests that the incentive to MBE is higher for firms with longer MBE strings, i.e., consecutive periods of MBE. More specifically, firms that consistently achieve analysts’ forecasts have a significantly higher earnings response coefficient (Lopez & Rees, 2002) and firms with longer MBE strings experience a more negative stock price response when the MBE string is broken (e.g., Barth, Elliott, & Finn, 1999; Kasznik & McNichols, 2002; Ke, Huddart, & Petroni, 2003; Skinner & Sloan, 2002).