Hierarchy of earnings thresholds based on discretionary accruals |
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| Institution: | 1. School of Accounting, College of Business Administration, Florida International University, USA;2. Accounting Department, College of Business, San Francisco State University, USA;3. Department of Accounting, Finance and Economics, College of Business and Public Policy, California State University, Dominguez Hills, USA;1. School of Business and Management, State University of New York, College at Brockport, United States;2. Manning School of Business, University of Massachusetts Lowell, United States;1. Binghamton University – SUNY, USA;2. The Ohio State University, USA;1. School of Business, University of Houston – Victoria, Victoria, TX 77901, USA;2. Rm 389, School of Business, University at Albany – SUNY, 1400, Washington Ave, Albany, NY 12222, USA;3. Rm 357, School of Business, University at Albany – SUNY, 1400, Washington Ave, Albany, NY 12222, USA;1. Collins College of Business, University of Tulsa, United States of America;2. Crummer Graduate School of Business, Rollins College, United States of America;3. Saunders College of Business, Rochester Institute of Technology, United States of America |
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| Abstract: | Prior studies identify hierarchies of earnings thresholds based on distributions of earnings (e.g., Degeorge et al., 1999) and survey opinions of CFOs (Graham, Harvey, & Rajgopal, 2005). We complement extant literature by investigating a threshold hierarchy in the context of accounting discretion exercised by managers. We examine the relative extent of discretionary accruals used to achieve three earnings thresholds—avoiding losses, avoiding earnings declines, and avoiding negative earnings surprises. Our empirical findings suggest that managers are likely to use the largest amount of discretionary accruals to avoid earnings declines, and the least amount of discretionary accruals to avoid negative earnings surprises. Thus, this study identifies the hierarchy of the earnings thresholds based on accounting discretion used in financial reporting. We also find that the hierarchy remains stable over the last two decades during our sample period. Then, we provide several explanations for why managers are likely to exercise more accounting discretion to avoid earnings declines. These explanations include earnings smoothing, reduction of stock returns volatility, and signaling of future growth potential. Overall, this study provides new insights into accruals management behavior. |
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