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By Messod D. Beneish, Eric Press and Mark E. Vargus


Abstract: The paper uses a large sample of 488 firms that experience technical default between 1983 and 1997 to examine managers ’ accrual strategies and their insider trading behavior in the period preceding the event of default. Our results are consistent with our conjecture that insider trading is informative about firms ’ expected costs of default, and with our expectation that insider trading measures are related to both pre-default earnings management and post-default stock returns. We find that managers facing higher expected costs of default make income increasing accrual choices and that managers ’ exercise of discretion is successful in staving-off default. We also find that although managers are ultimately unable to avoid default, by delaying both the violation and subsequent adverse stock-market response, managers benefit by selling their equitycontingent wealth at higher prices. To our knowledge, our paper is the first to show that upwardly managed accruals are successful in avoiding default, and to provide new evidence on how managers benefit from delaying default. Our results also suggest that investigating managers ’ trading patterns is useful in determining the likelihood of pre-default earnings management

Year: 2011
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