To What Extent Does the Financial Reporting Process Curb Earnings Surprise Games?

Managers play earnings surprise games to avoid negative earnings surprises by managing earnings upward or by managing analysts' earnings expectations downward. We investigate the effectiveness of the financial reporting process at restraining earnings surprise games. Because the annual reportin...

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Bibliographic Details
Published in:Journal of accounting research 2007-12, Vol.45 (5), p.947-981
Main Authors: BROWN, LAWRENCE D., PINELLO, ARIANNA SPINA
Format: Article
Language:English
Subjects:
Accounting research
Analytical forecasting
Business accounting
Creative accounting
Earnings
Earnings forecasting
Earnings management
Economic efficiency
Financial accounting
Financial analysis
Financial information
Financial management
Financial regulation
Financial reporting
Forecasting models
Logistic regression
Modeling
Proxy reporting
Proxy statements
Variable coefficients
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Summary:Managers play earnings surprise games to avoid negative earnings surprises by managing earnings upward or by managing analysts' earnings expectations downward. We investigate the effectiveness of the financial reporting process at restraining earnings surprise games. Because the annual reporting process is subject to an independent audit and more rigorous expense recognition rules than interim reporting, it provides managers with fewer opportunities to manage earnings upward. We document that, relative to interim reporting, annual reporting reduces the likelihood of income-increasing earnings management and, to a lesser extent, of negative surprise avoidance, but increases the magnitude of downward expectations management. Our findings suggest that regulatory attempts to monitor corporations' internal checks and balances are likely to be more effective at curbing upward earnings management than at mitigating negative surprise avoidance.
ISSN:0021-8456
1475-679X
DOI:10.1111/j.1475-679X.2007.00256.x