An Analysis of Managerial Use and Market Consequences of Earnings Management and Expectation Management

52 Pages Posted: 20 Sep 2008 Last revised: 15 Mar 2012

See all articles by Somnath Das

Somnath Das

University of Illinois at Chicago

Kyonghee Kim

Michigan State University

Sukesh Patro

Northern Illinois University

Date Written: April 1, 2011

Abstract

This study examines how managers coordinate the joint use of earnings management and expectation management by estimating the relationship between these instruments and how this relationship changes as their respective constraints change. We do this by estimating structural models of the two instruments that account for the constraints on their use as well as their effects on each other. Our results suggest that managers use earnings management and expectation management complementarily when managers’ ability to use earnings management is less restricted. However, as the constraints on earnings management increase, managers substitute earnings management with expectation management. Moreover, we find that the extent of expectation management influences the extent of earnings management, but not vice versa. Examining the market consequences of the use of these instruments, we find that, while there are penalties for using both earnings management and expectation management, either as complements or as substitutes, the net stock price benefit from meeting or beating earnings targets exceeds these penalties.

Keywords: earnings management, expectation management, market response, benchmark beating

JEL Classification: G14, G29, M41, M43, M45

Suggested Citation

Das, Somnath and Kim, Kyonghee and Patro, Sukesh, An Analysis of Managerial Use and Market Consequences of Earnings Management and Expectation Management (April 1, 2011). The Accounting Review, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1270841 or http://dx.doi.org/10.2139/ssrn.1270841

Somnath Das

University of Illinois at Chicago ( email )

601 South Morgan Street
University Hall, Room 2303
Chicago, IL 60607
United States
312-996-4482 (Phone)
312-996-4520 (Fax)

Kyonghee Kim (Contact Author)

Michigan State University ( email )

N206 North Business Complex
632 Bogue Street
East Lansing, MI 48824
United States
517-432-2920 (Phone)

Sukesh Patro

Northern Illinois University ( email )

236P Barsema Hall
DeKalb, IL 60115
United States
8157531354 (Phone)

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