Internal Performance Measures and Earnings Management: Evidence from Segment Earnings

We examine whether the design of a firm’s internal management accounting system is associated with GAAP earnings management. We exploit the fact that ASC 280 mandates a “management approach” requiring multisegment firms to disclose their segment earnings as defined internally by their management acc...

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Bibliographic Details
Published in:The Accounting review 2024-01, Vol.99 (1), p.259-283
Main Authors: Gross, Christian, Wagenhofer, Alfred, Windisch, David
Format: Article
Language:English
Subjects:
Companies
Decision making
Earnings
Earnings management
Financial performance
GAAP
Internal accounting control
Lines of business reporting
Management accounting
Usefulness
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Summary:We examine whether the design of a firm’s internal management accounting system is associated with GAAP earnings management. We exploit the fact that ASC 280 mandates a “management approach” requiring multisegment firms to disclose their segment earnings as defined internally by their management accounting system. We posit that the less these segment earnings are decoupled from GAAP earnings, the higher are the costs of earnings management because earnings management spills over to segment earnings and distorts information used for internal decision-making. Thus, we predict that firms with more decoupled segment earnings engage in more earnings management. Using a large sample of U.S. firms from 1998 to 2020, we find support for this prediction. We also find that the decision usefulness of segment earnings for segment investment purposes decreases as earnings management increases, with this association being more pronounced for firms with less decoupled segment earnings measures. Data Availability: Data are available from the public sources cited in the text. JEL Classifications: M41; G14.
ISSN:0001-4826
1558-7967
DOI:10.2308/TAR-2019-0155