Earnings Management to Report an Additional Cent of Eps: Evidence from Pre- and Post-Sox Periods

INTRODUCTION Schipper (1989, p. 92) takes a relatively broad view of earnings management by indicating that the notion really embodies disclosure management "in the sense of a purposeful intervention in the external financial reporting process, with the intent of obtaining personal gain (as opposed to say, merely facilitating the neutral operation of the process). " This view suggests various financial statement items could be the object of manipulation. For example, Cullen et al. (2008) provide evidence that companies with a history of reporting net losses and negative operating cash flows often manipulate sales revenue (rather than earnings) to boost market value. Even if one confines disclosure management strictly to earnings management, research shows that various forms of earnings are manipulated and for different reasons. For example, income may be managed to ensure that reported earnings per share (EPS) meets analysts' forecasts (e.g., Payne & Robb, 2000). Alternatively, studies (e.g., Guan et al., 2006; Lin et al. 2014) suggest that net income is frequently manipulated upward to reach cognitive reference points for users (e.g., unmanipulated earnings of $3.94 million would be enhanced to just above $4.00 million). Regardless of the particular financial statement item being manipulated, a key point of Schipper's (1989) definition of disclosure (earnings) management is management's intervention in the outcome of the financial reporting process rather than their neutral facilitation of it. That is, disclosure (earnings) management results in biased financial reporting. Recent research suggests that at least some forms of earnings management declined significantly in the U.S. following the implementation of the Sarbanes-Oxley Act of 2002 (SOX). For example, Bartev and Cohen (2009) and Cohen et al. (2008) present evidence that accrual-based earnings management declined markedly after SOX. Aono and Guan (2008), Lin and Wu (2014), and Wilson (2012) indicate that earnings manipulation to reach user reference points in income largely disappeared after SOX. Similarly, Jordan and Clark (2013) provide results suggesting the upward manipulation of sales revenue to reach user reference points vanished after SOX as well. Although some studies show that particular forms of earnings management declined precipitously after SOX, research also indicates that other types (e.g., real earnings management) actually increased in the post-SOX era (e.g., see Bartev & Cohen, 2009; Cohen et al. 2008). Still, other research suggests "that the regulatory changes initiated under SOX to empower boards and audit committees" produced little, if any, effect on the incidence of earnings management (Ghosh et al. 2010, p. 1145). Thus, SOX's impact on earnings management appears inconclusive at this point, and further research in the area is warranted. The current article examines a specific form of earnings management documented in the literature whereby income is manipulated so that EPS can be rounded up to report one more cent of EPS (Das & Zhang, 2003; Jorgensen et al. 2014; Miller et al. 2012). The present research replicates the key portion of these studies but does so in both pre- and post-SOX eras to determine if this corporate governance legislation produced any apparent effects on management's propensity to manipulate income to report an additional cent of EPS. The results provide clear evidence of this manipulative behavior prior to SOX but no indications of it in the post-SOX period, thus implying SOX produced a positive impact by contributing to the elimination of this form of biased financial reporting. The next section discusses the literature relative to the intentional rounding up of EPS and also develops the research question for the study. This is followed by sections on methodology and data and results. The final section contains our discussion and conclusion. LITERATURE REVIEW Degeorge et al. …