The Effects of Real Earnings Management on the Firm, Its Competitors and Subsequent Reporting Periods

Prior research hypothesizes that managers use a variety of real actions to manage reported earnings to meet or beat certain key benchmarks. Combining two years of new supermarket scanner data for a commodity consumer product with firm-level financial data, I find evidence consistent with the hypothesis of price discounting around the fiscal quarter-end. Firms that just beat prior year quarterly Earnings per Share or Analyst Consensus Earnings Forecasts reduce prices in the final month of the fiscal quarter to do so even when controlling for the effects of a competing hypothesis that firms adjust prices when inventory levels are unusually high. Also examined are the effects of earnings management related price reductions on subsequent reporting periods and on competitor pricing behavior. I find that price reductions associated with a single earnings management target are persistent over multiple reporting periods and that competitors also reduce prices when a firm has greater incentives to accelerate earnings. These findings suggest the effects of Real Earnings Management on subsequent reporting periods and competitor behavior are greater than previously thought and make contribute to both the marketing and accounting literature in the following ways: analyzing the effect of price discounts on earnings as opposed to the effect on sales volumes and revenues; demonstrating evidence that firms manufacturing durable goods reduce prices (an increase in promotional activities) when incentives to boost earnings are stronger; offering direct evidence of the actions taken to manage earnings, as opposed to the prior research which uses Abnormal Cash Flow from Operations as a proxy for earnings management actions; providing evidence that firms change pricing behavior in response to competitor earnings management incentives; showing that price reductions associated with earnings management become persistent and can be repeated as much as twelve months later.