Analyst Coverage and Real Earnings Management: Quasi-Experimental Evidence

Abstract

We study how securities analysts influence managers' use of different types of earnings management. To isolate causality, we employ a quasi-experiment that exploits exogenous reductions in analyst following resulting from brokerage house mergers. We find that managers respond to the coverage loss by decreasing real earnings management, while increasing accrual manipulation. These effects are significantly stronger among firms with less coverage and for firms close to the zero-earnings threshold. Our causal evidence suggests that managers use real earnings management to enhance short-term performance in response to analyst pressure, effects that are not uncovered when focusing solely on accrual-based methods. JEL Classification: D82; G24; G34; M41.

Firms’ innovation strategy under the shadow of analyst coverage

“…Bushee (1998) finds that managers are more inclined to cut R&D expenses in response to a decrease in earnings and that this is more likely to happen when a large portion of institutional owners are non-dedicated (i.e., short-term) investors. A related paper by Yu (2008) finds, in contrast, that firms with more analysts manage their accrual-based earnings less, and recent work by Irani and Oesch (2016) suggests that managers decrease real earnings management but increase accrual manipulation when they are followed by more analysts. We contribute to the earnings management literature by studying the effect of analysts on firms' decisions to cut R&D expenses and its consequence on the innovation output.…”

“…The dependent variable ExternalInnov (i,t+k) corresponds to our proxies for external innovation activities: acquisitions (Acquisition and LnAcquisitions) and CVC (CVC Setup and CVC 33 In the regressions where the dependent variable corresponds to the CVC Setup (columns (7) and (8)), we cannot include firm fixed effects due to the way in which the variable is defined (see variable definitions in Table 1). Since this variable is set to missing after firms have set up a CVC fund, taking into account the within-firm variation (i.e., including a firm fixed effect), creates a selection bias because only those firms that set up CVC funds after the merger events (i.e., those for which there is no missing data post-merger) are considered when computing the average effect.…”

“…These effects are economically and statistically significant, which is consistent with our OLS and IV results in the previous sections. 33 …”

Labor Union and Real Earnings Management

“…We include NUMEST as a control variable to control for the effect of corporate governance according to previous studies of analyst coverage and real EM (Irani and Oesch 2016). Analysts play an important role in mitigating information asymmetry (Chun and Shim 2017;Shim and Ki 2017).…”

A Study of Determinants of Predictive Accuracy of Analysts? Estimates of Earnings in Indian Markets

“…Information required by analysts' to generate such recommendations comes in the form of, announcements by the firm, publically available information and private information sources (Irani and Oesch, 2016). Firms follow discretionary disclosure policies for the supplementary information they have to disseminate in the market, but for the regulatory purpose, they have to adhere to the minimum disclosure norms prescribed by the regulator.…”