Is ‘benchmark beating’ by Australian firms evidence of earnings management?

We investigate the extent to which Australian firms that report small profits and/or small increases in earnings (i.e. benchmark beaters) have done so by the upward manipulation of these earnings. Although evidence of an unusually large number of firms managing to just beat such earnings benchmarks has been interpreted as evidence of earnings management, this approach fails to identify those firms that are the manipulators from those where unbiased earnings fall naturally into the benchmark beating group. Our results suggest that caution is required in interpreting benchmark beating as an indicator of the extent of earnings management. Using several methods for estimating the unexpected accrual component of earnings, we show that although benchmark beaters have larger positive unexpected accruals than other firms, a similar result holds when firms with small losses or earnings declines (i.e. ‘just miss’ firms) are compared with other firms. Moreover, there is no statistically significant difference between unexpected accruals for the benchmark beating and just miss groups. At a minimum, we reject the joint hypothesis that unexpected accruals capture earnings management and that an unusual kink around zero in the distribution of earnings levels or earnings changes is caused by earnings management.