Maintaining a reputation for consistently beating earnings expectations and the slippery slope to earnings manipulation

This paper investigates whether maintaining a reputation for consistently beating analysts’ earnings expectations can motivate executives to move from “within GAAP” earnings management to “outside of GAAP” earnings manipulation. We analyze firms subject to SEC enforcement actions and find that these firms consistently beat analysts’ quarterly earnings forecasts in the three years prior to the manipulation period and continue to do so by smaller “beats” during the manipulation period. We find that manipulating firms beat expectations around 86 percent of the time in the twelve quarters prior to the manipulation period (versus 75 percent for control firms) and that manipulation often ends with a miss in expectations. We document that executives of manipulating firms face strong stock market and CEO pressure to perform. Prior to the manipulation period, these firms have high analyst optimism, growing institutional interest, and high market valuations, along with powerful CEOs. Further, we find that maintaining a reputation for beating expectations is more important than CEO overconfidence and is incremental to CEO equity incentives for explaining manipulation. Our results suggest that pressure to maintain a reputation for beating analysts’ expectations can encourage aggressive accounting and, ultimately, earnings manipulation

Applying Benford’s law to detect accounting data manipulation in the banking industry

We utilise Benford’s Law to test if balance sheet and income statement data broadly used to assess bank soundness were manipulated prior to and also during the global financial crisis. We find that all banks resort to loan loss provisions to manipulate earnings and income upwards. Distressed institutions that have stronger incentives to conceal their financial difficulties resort additionally to manipulating loan loss allowances and non-performing loans downwards. Moreover, manipulation is magnified during the crisis and expands to encompass regulatory capital

Earnings Prediction with Deep Leaning

In the financial sector, a reliable forecast the future financial performance of a company is of great importance for investors' investment decisions. In this paper we compare long-term short-term memory (LSTM) networks to temporal convolution network (TCNs) in the prediction of future earnings per share (EPS). The experimental analysis is based on quarterly financial reporting data and daily stock market returns. For a broad sample of US firms, we find that both LSTMs outperform the naive persistent model with up to 30.0% more accurate predictions, while TCNs achieve and an improvement of 30.8%. Both types of networks are at least as accurate as analysts and exceed them by up to 12.2% (LSTM) and 13.2% (TCN).Comment: 7 pages, 4 figures, 2 tables, submitted to KI202

CEO Profile and Earnings Quality

This paper introduces the PSCORE, which aggregates nine personal characteristics of chief executive officers (CEOs), to signal the quality of earnings. The PSCORE is a composite score based on publicly available data on CEOs. The study reports strong positive relationships between the PSCORE and two different proxies for earnings quality, (i) discretionary accruals and (ii) financial statement errors, measured by deviations of the first digits of figures reported in financial statements from those expected by Benford’s Law. Further analyses indicate that the relationships between the PSCORE and the proxies for earnings quality become more pronounced when CEOs have high equity-based compensation incentives. The findings have some implications for practitioners

Accuracy of direct genomic values in Holstein bulls and cows using subsets of SNP markers

Background: At the current price, the use of high-density single nucleotide polymorphisms (SNP) genotyping assays in genomic selection of dairy cattle is limited to applications involving elite sires and dams. The objective of this study was to evaluate the use of low-density assays to predict direct genomic value (DGV) on five milk production traits, an overall conformation trait, a survival index, and two profit index traits (APR, ASI). Methods. Dense SNP genotypes were available for 42,576 SNP for 2,114 Holstein bulls and 510 cows. A subset of 1,847 bulls born between 1955 and 2004 was used as a training set to fit models with various sets of pre-selected SNP. A group of 297 bulls born between 2001 and 2004 and all cows born between 1992 and 2004 were used to evaluate the accuracy of DGV prediction. Ridge regression (RR) and partial least squares regression (PLSR) were used to derive prediction equations and to rank SNP based on the absolute value of the regression coefficients. Four alternative strategies were applied to select subset of SNP, namely: subsets of the highest ranked SNP for each individual trait, or a single subset of evenly spaced SNP, where SNP were selected based on their rank for ASI, APR or minor allele frequency within intervals of approximately equal length. Results: RR and PLSR performed very similarly to predict DGV, with PLSR performing better for low-density assays and RR for higher-density SNP sets. When using all SNP, DGV predictions for production traits, which have a higher heritability, were more accurate (0.52-0.64) than for survival (0.19-0.20), which has a low heritability. The gain in accuracy using subsets that included the highest ranked SNP for each trait was marginal (5-6%) over a common set of evenly spaced SNP when at least 3,000 SNP were used. Subsets containing 3,000 SNP provided more than 90% of the accuracy that could be achieved with a high-density assay for cows, and 80% of the high-density assay for young bulls. Conclusions: Accurate genomic evaluation of the broader bull and cow population can be achieved with a single genotyping assays containing ∼ 3,000 to 5,000 evenly spaced SNP

Analyst information precision and small earnings surprises

This study proposes and tests an alternative to the extant earnings management explanation for zero and small positive earnings surprises (i.e., analyst forecast errors). We argue that analysts’ ability to strategically induce slight pessimism in earnings forecasts varies with the precision of their information. Accordingly, we predict that the probability that a firm reports a small positive instead of a small negative earnings surprise is negatively related to earnings forecast uncertainty, and we present evidence consistent with this prediction. Our findings have important implications for the earnings management interpretation of the asymmetry around zero in the frequency distribution of earnings surprises. We demonstrate how empirically controlling for earnings forecast uncertainty can materially change inferences in studies that employ the incidence of zero and small positive earnings surprises to categorize firms as suspected of managing earnings

Effect of perceived default risk and accounting information quality on the decision to grant credit to SMEs

ABSTRACT: The present study analyses the influence that perceived default risk and accounting information quality have on the process of credit granting to SMEs. Empirical evidence was obtained from a survey of 471 bank loan officers in Spain, in which they were asked to answer questions relating to audited and not-audited firms. Through a Structural Equations Modeling (SEM) approach, the results confirm that the likelihood that the loan officers are more willing to provide access to credit to SMEs, and to do so in more favourable conditions, is negatively influenced by perceived default risk and positively influenced by the general perception about accounting information quality. Besides, we find that information quality is an antecedent of perceived risk, so that the latter becomes the central element of the research model. Additionally, the perceptions of the decision-makers regarding all the analysed variables are better for the audited SMEs than for the unaudited ones

Management earnings forecasts and IPO performance: evidence of a regime change

Companies undertaking initial public offerings (IPOs) in Greece were obliged to include next-year profit forecast in their prospectuses, until the regulation changed in 2001 to voluntary forecasting. Drawing evidence from IPOs issued in the period 1993–2015, this is the first study to investigate the effect of disclosure regime on management earnings forecasts and IPO long-term performance. The findings show mainly positive forecast errors (forecasts are lower than actual earnings) and higher long-term returns during the mandatory period, suggesting that the mandatory disclosure requirement causes issuers to systematically bias profit forecasts downwards as they opt for the safety of accounting conservatism. The mandatory disclosure requirement artificially improves IPO share performance. Overall, our results show that mandatory disclosure of earnings forecasts can impede capital market efficiency once it goes beyond historical financial information to involve compulsory projections of future performance