Discretionary Accruals and Earnings Management: An Analysis of Pseudo Earnings Targets

Abstract

We investigate whether the positive associations between discretionary accrual proxies and beating earnings benchmarks hold for comparisons of groups segregated at other points in the distributions of earnings, earnings changes, and analystsbased unexpected earnings. We refer to these points as “pseudo” targets. Results suggest that the positive association between discretionary accruals and beating the profit benchmark extends to pseudo targets throughout the earnings distribution. We find similar results for the earnings change distribution. In contrast, we find few positive associations between discretionary accruals and beating pseudo targets derived from analysts-based unexpected earnings. We develop an additional analysis that accounts for the systematic association between discretionary accruals and earnings and earnings changes. Results suggest that the positive association between discretionary accruals and earnings intensifies around the actual profit benchmark (i.e., where earnings management incentives may be more pronounced). We find similar effects around the actual earnings increase benchmark. However, analogous patterns exist for cash flows around the profit and earnings increase benchmarks. In sum, we are unable to eliminate other plausible explanations for the associations between discretionary accruals and beating the profit and earnings increase benchmarks.

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