Manipulating Sales Revenue To Achieve Cognitive Reference Points: An Examination Of Large U.S. Public Companies

Abstract

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-family: Times New Roman; font-size: x-small;">Significant research (e.g., Carslaw, 1988; Thomas, 1989) provides evidence that managers manipulate earnings to reach cognitive reference points in income.<span style="mso-spacerun: yes;">  </span>More specifically, when the second-from-the-left earnings digit falls just below zero, management finds ways to round earnings up to just above this breakpoint so that the first earnings digit increases by one.<span style="mso-spacerun: yes;">  </span>The current study demonstrates that for a sample of large publicly-traded U.S. companies this same type of manipulative behavior appears to be occurring with respect to reported sales revenue.</span></p>

Digital Analysis Of Sales And Industry Partition: An Examination Of U.S. Public Companies

“…Contrary to previous studies, there is no significant lack of high digits (7, 8 or 9) at either the five or one percent level. The comparison of the observed distribution of Table 2 with the observed distribution of the sample of Jordan et al (2009) shows no significant difference at the 10 percent level (Chi-square = 9.479, df = 9, p-value = 0.394). In other words, the CSM observed in 2006 in a sample of U.S. public companies continues in 2008.…”

“…The results reported in Table 2 are consistent with previous studies. But this study isn't limited to the largest 1,002 U.S. public companies such as is the case with Jordan et al (2009). The proportion of digit zero in the second place is higher than expected (significant at the 1% level).…”

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Previous studies have shown that companies' managers tend to round-up reported earnings (Carslaw, 1988;Thomas, 1989;Niskanen & Keloharju, 2000) and sales revenue (Jordan et al, 2009). The frequency of zero as second digit in earnings and sales is much higher than expected frequency.

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“…earnings before extraordinary items, net income, earnings per share) are the most examined accounting variables in empirical studies concerning digital analysis. Two exceptions are the study ofJordan et al (2009) which is focused on sales andNigrini (1996) which used Benford's law in a U.S. tax compliance context.  Few studies examined rounding-up behavior related to company characteristics.…”

The ASC 606 standard, revenue informativeness, and analysts forecast quality

“…The critical role of revenue in the valuation and stewardship functions of accounting give managers an incentive to manipulate revenue. Jordan et al (2009) find evidence of managers rounding revenue numbers upward to whole numbers to reach a new cognitive reference point.…”