Working Paper: CEPR ID: DP1790
Authors: Francois Degeorge; Jayendu Patel; Richard Zeckhauser
Abstract: Investors are keenly interested in financial reports of earnings because earnings provide important information for investment decisions. Thus, executives who are monitored by investors and directors face strong incentives to manage earnings. We introduce consideration of behavioural/institutional thresholds for earnings in this mix of incentives and governance. A model illustrates how thresholds induce specific types of earnings management. Empirical explorations find clear support for earnings management to exceed each of the three thresholds that we consider: positive profits, sustain-recent-performance, and meet-market-expectations. The thresholds are hierarchically ranked. The future performance of firms that possibly boost earnings to just cross a threshold appears to be poorer than that of less suspect control groups.
Keywords: Earnings Management; Behavioral Finance; Thresholds
JEL Codes: G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| thresholds (C24) | earnings management (M52) |
| earnings management (M52) | future performance (L25) |
| thresholds (C24) | future performance (L25) |