Though of great interest to regulators and practitioners, real earnings management (REM) – the practice of altering operating and investing transactions to meet financial targets and mislead stakeholders – can be extremely challenging to measure. This difficulty is heightened by the fact that firms might change their transactions for strategic business reasons, rather than intent to mislead.
In an article recently published by Contemporary Accounting Research, Brattle Senior Associate Dr. Adrienna Huffman and her coauthors present a new measure to better distinguish earnings manipulation from strategic changes. Their comprehensive approach is designed to reflect the concurrent use of multiple REM activities and other signals that indicate an elevated risk of manipulation. The authors compare their new approach to standard REM measures and find that it performs better than existing metrics across various dimensions, and may be particularly useful in research settings.
The full article, “A Simple Approach to Better Distinguish Real Earnings Manipulation from Strategy Changes,” is available below.