A Reexamination of Real Earnings Management from a Firm-Specific Time-Series Perspective

Managers use real earnings management (REM) to influence reported earnings through the manipulation of real business activities. Extant literature generally employs crosssectional analysis to identify REM, but newer studies suggest that these traditional REM measures are severely mis-specified. In this study, we employ a new methodology that utilizes firm-specific time-series characteristics of discretionary expenses to identify REM. Using this new REM measure, we find that firms engage in REM to meet or just beat zero earnings and to meet or just beat consensus analyst forecasts, a finding that is not strongly supported by traditional REM measures. Prior literature also suggests that some managers and researchers believe that REM is myopic and imposes real costs on firms, but there is mixed empirical evidence regarding the impact of REM on future operating performance. We find that firms that opportunistically engage in REM perform, on average, neither better nor worse in the future, a finding consistent with survey responses suggesting that managers are careful not to sacrifice future operating performance in order to meet or just beat earnings benchmarks. Additional analysis shows that firms with high ability managers that engage in REM have better future operating performance.