Questions On Financial Earnings Management

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Prior studies (e.g., Burgstahler and Dichev 1997; Degeorge, Patel and Zeckhauser 1999) identify three earnings thresholds managers seek to achieve when they report financial statements: avoiding negative earnings, avoiding earnings declines, and avoiding negative earnings surprises. A large number of studies use these three earnings thresholds to test earnings management in various research settings. This dissertation investigates another potential earnings management threshold, peer performance, which has been largely ignored in the extant literature.
Both Burgstahler and Dichev (1997) and Degeorge et al. (1999) explain threshold-driven earnings management behavior by referring to the prospect theory (Kahneman and Tversky 1979), which suggests that for a given increase in wealth, the corresponding increase in value is the greatest when the increase in wealth moves from negative to positive territory relative to a reference point (viz., zero earnings, zero change in earnings or zero forecast error). While they do not specifically explain the formulation of reference points or the usage of other reference points beyond those extensively investigated three earnings thresholds, they imply the existence of other reference points (Burgstahler and Dichev 1997), ). and They also suggest that if other reference points are used either by corporate boards or investors, and if those reference points are reflected in the executives’ reward schedulesor compensation contracts, executives
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