Voluntary Management Earnings

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Voluntary management earnings

forecasts and discretionary
accruals: evidence from Danish
IPOs
a b
Jeffrey D. Gramlich & Ole Sørensen
a
University of Southern Maine
b
Copenhagen Business School
Published online: 08 Jun 2010.
To cite this article: Jeffrey D. Gramlich & Ole Sørensen (2004): Voluntary management
earnings forecasts and discretionary accruals: evidence from Danish IPOs , European
Accounting Review, 13:2, 235-259
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European Accounting Review, Vol. 13, No. 2, 235 – 259, 2004
Voluntary Management Earnings Forecasts

and Discretionary Accruals: Evidence from
Danish IPOs
JEFFREY D. GRAMLICH AND OLE SØRENSEN

University of Southern Maine

Copenhagen Business School
(Received August 2001; accepted September 2003)
ABSTRACT This paper seeks to determine whether Danish managers exercise

discretionary accruals to reach earnings forecast targets they voluntarily specify in
conjunction with initial public offerings (IPOs). Because the Danish accounting and legal
environment is more permissive than the US, we use Denmark as a natural laboratory for
learning how business would occur without strict rules, enforcement and sanctions.
Danish managers often volunteer pro forma financial statements for results that are
expected to occur subsequent to the IPO. We examine a sample of 58 Danish firms that
issue voluntary management earnings forecasts in connection with IPOs that occur
between 1984 and 1996. The evidence we uncover strongly suggests that pre-managed
earnings are adjusted toward these targets. In contrast with Kasznik’s (1999) results
related to voluntarily forecasting American firms, managers of Danish firms exercise
discretionary accruals to mitigate earnings forecast errors regardless of whether pre-
managed earnings are less, or greater, than the IPO forecast amount.
1. Introduction
Disclosure of management earnings forecasts is optional in the US but is
effectively discouraged by the likelihood of potentially high litigation costs
related to an overestimation of post-IPO earnings.1 In some countries the
inclusion of forecast earnings is a mandatory component of an initial public
offering (IPO) prospectus.2 In other countries, firms possess the option of
disclosing earnings forecasts in IPO-related documents, and the reporting
Correspondence Address: Jeffrey Gramlich, L. L. Bean/Lee Surace Professor of

Accounting, University of Southern Maine School of Business, Luther Bonney Hall,
Portland, ME 04104-9300, USA.
0963-8180 Print/1468-4497 Online/04/020235-25 # 2004 European Accounting Association

DOI: 10.1080/0963818042000203338
Published by Routledge Journals, Taylor & Francis Ltd on behalf of the EAA.
236 J. D. Gramlich and O. Sørensen
environments in those countries are such that many managers deliberately choose
to make such voluntary disclosures. These countries include the United Kingdom
and Denmark, where most companies include forecasts, and Canada, where there
is a fairly even split between the number of companies that include an earnings
forecast with an IPO prospectus and the number that do not. Trueman (1986),
Frankel et al. (1995) and Mak (1996) examine why certain firms in voluntary
environments reveal more forecast information than others do. This study
addresses a different question. Given that certain firms elect to issue an IPO-
related earnings forecast, to what extent do managers subsequently adjust
earnings to meet these forecasts?
Dutta and Gigler (2002) theorize that investors benefit from receiving voluntary
management earnings forecasts in spite of related incentives for earnings
management. They analytically determine that the benefit of receiving earnings

forecasts exceeds the cost that investors incur because they subsequently receive
earnings that are the result of ‘window dressing’ that is needed to reach the forecast
target. In short, without the ability to window dress earnings, managers would be
unlikely to voluntarily release forecasts that contain valuable economic
information about the firm. Interestingly, because of the economic information
inherent in an earnings forecast, the authors determine that less window dressing
latitude is available to managers and therefore less earnings management is
expected when managers forecast earnings. Dutta and Gigler note, however, that
even in the presence of earnings forecasts, managers are expected to manage
earnings. Finally, they find that an optimal incentive setting is one in which
managers desire to manage earnings upward to reach high forecasts but not
downward to reach low forecasts. Given the frequent issuance of IPO-related
earnings forecasts in Denmark, an empirical question is whether managers perceive
such earnings forecast targets as symmetric or asymmetric incentives.
Kasznik (1999) examines a sample of 366 publicly held US firms (499 firm-
years) that issued voluntary earnings forecasts between 1987 and 1991. When
forecasting firms overestimate their earnings, his results support the finding of
income-increasing discretionary accruals. However, in contrast with the results
we find, Kasznik does not find evidence of income-decreasing accruals among
underestimating firms. Considering the large number of public US firms,
Kasznik’s sample of 499 firm-years across a five-year period is relatively small.3
Thus, his results apply only to a relatively small portion of US firm-years that
have chosen to voluntarily release earnings forecasts. While Kasznik does not
investigate differences between this sample and the overall population of firms, it
is likely that Kasznik’s subset of firms reflects certain unique systematic
characteristics. In other words, it is likely that the sample is tainted by self-
selection bias (for further discussion and an example, see Frankel et al., 1995).
We uncover strong evidence suggesting that managers of Danish IPO firms use
discretionary accruals, both positive and negative, to reach the earnings targets they
voluntarily specify in their IPO disclosures. This apparent earnings management
occurs in spite of the stated objective of the Danish Financial Statement Act that
Voluntary Management Earnings Forecasts and Discretionary Accruals 237
financial statements present a true and fair view of the assets and liabilities of the
company, the financial position and its profit or loss. In adjusting earnings to reach
forecasted targets, managers are presumably attempting to establish positive
reputations for reasons such as raising the company’s stock price and/or increasing
the value of their own human capital. The discretionary accruals mitigate earnings
forecast errors regardless of whether pre-managed earnings are higher or lower than the
IPO forecast amount. Thus, Danish managers apparently view their earnings forecasts
as symmetric incentives. Dutta and Gigler (2002) suggest that such symmetry is less
optimal than an asymmetric setting in which managers are rewarded for reaching high
earnings targets but are not penalized for exceeding low earnings targets.
The present study differs from Kasznik (1999) in key aspects. First, we
examine only IPO firms. As private firms prior to the IPO, comparatively
little pre-IPO information is available to external investors; managers therefore

possess relatively more information (i.e. a highly asymmetric information state
exists). Thus, it is likely that earnings forecasts voluntarily released by
management play a larger information role for IPO investors than for existing
public companies.4 Second, all of the IPO firms in this study are domiciled in
Denmark, not the US. The Danish legal environment is not as punitive to
managers for the losses of company investors, so managers are presumably
motivated more by contractual relations with investors and less by legal
requirements and potential legal penalties. While the applicability of the results is
limited to Danish IPO firms during the period from 1984 to 1996, the findings
also potentially provide a hypothetical result of what might occur without
government regulations.5 In other words, by examining Danish IPO firms we are
better able to address the question: Would there be accruals management toward
earnings forecasts in an environment where there is less enforcement of
accounting standards? Incorporating the results of other studies such as Kasznik
(1999) and Magnan and Cormier (1997), we can begin to understand the relative
effects legal environments and contractual relationships on the motivation to use
discretionary accruals to reach voluntarily disclosed earnings forecast targets.
The next section of this paper provides a brief literature review and
development of the hypothesis. The third section describes the methodology we
utilize to determine whether managers exercise discretionary accruals to reach
self-prescribed targets. The fourth section presents the results of our tests of
discretionary accruals. The paper concludes with a brief summary.
2. Literature Review, Motivation and Hypothesis Development

It is not readily apparent why a manager would opt to disclose an earnings forecast
when it is not required. Revealing voluntary earnings forecast information is, after
all, one way for a manager to set herself up for failure and one possible reaction
would be to simply avoid making such a prediction. On the other hand, both
analytical and empirical evidence indicates that in many circumstances firms can
reduce uncertainty and thereby lower their cost of capital by revealing additional
credible information (Verrecchia, 1983; Diamond, 1985; Trueman, 1986; Fishman

and Hagerty, 1989; Healy and Palepu, 1993; Richardson, 1998). But product
market forces can sometimes outweigh capital market forces, removing a capital
market advantage for forecast disclosure in favour of a product market advantage
for secrecy (Healy and Palepu, 1993; Palepu et al., 2000). Thus, whether the
disclosure of a voluntary earnings forecast makes sense depends upon a firm’s
competitive situation relative to the other players in its product and capital markets.
Previous researchers have identified some of the characteristics of firms that
choose to voluntarily disclose earnings forecasts. Frankel et al. (1995) show that
US firms that issue capital often are more likely to reveal earnings forecasts on a
regular basis. Brennan’s (1999) evidence indicates that managers are more likely
to reveal earnings forecasts when a firm’s takeover bid is being contested than
when the bid is not being contested. Clarkson et al. (1992) find that voluntary
forecasters tend to reveal good news and that their forecast signals are usually
value-relevant. Among IPOs in New Zealand, Mak (1996) obtains evidence that
companies with high-variance returns are more likely to disclose extensive
forecast information than firms with low-variance returns, and that the proportion
of shares retained by inside owners is inversely related to the level of forecast
information disclosure. Aboody and Kasznik (2000) reveal evidence that
managers opportunistically time the release of voluntary earnings forecasts
relative to dates when CEO stock options are awarded. More recently, Baginski
et al. (2002) compare tendencies to release earnings forecasts between US and
Canadian firms; they find that American firms are likely to release earnings
forecasts when bad news is forthcoming while Canadian firms are likely to
release forecasts when good news is on the horizon, consistent with greater
litigation costs among US firms for failing to hit a forecast target.
In a closely related study, Clarkson et al. (1992) address the question of why
certain Canadian firms issue management earnings forecasts in connection with
IPOs. Their evidence indicates that managers of IPO firms tend to voluntarily
release earnings forecasts more often when they have good news to report (i.e.
future earnings are expected to be greater than would otherwise be predicted by
the trend of prior earnings). In addition, Clarkson et al. report that voluntary
forecasting IPO firms are viewed favourably by the stock market and result in
increased stock values (the valuation-relevance hypothesis). Kasznik (1999)
provides evidence supporting the view that only firms with good news to reveal
choose to make voluntary earnings forecasts. In any case, the fact that investors
willingly pay higher prices for shares in forecasting companies is de facto
evidence that the market views these forecasts as credible.
For a variety of possible reasons, substantial numbers of firms in certain less
litigious countries such as Canada and Denmark voluntarily choose to issue IPO-
related forecast information about expected post-IPO earnings performance.
Magnan and Cormier (1997) characterize these forecasts as important terms of an
implicit contract between a firm’s managers and its equity investors. Although
informal and usually without legal standing, breaches of such contracts carry
costs just as legally enforceable contracts do (Bowen et al., 1995). Thus, IPO-
related earnings forecasts are believed to offer management clear opportunities to
establish, or fail to establish, early positive reputations with investors.
Prior earnings management evidence based on US data supports the following
views related to capital-market-driven accruals:
. Managers choose income-increasing accruals prior to IPOs (Friedlan, 1994; Teoh

et al., 1998a; Teoh et al., 1998) and seasoned equity offers (Teoh et al., 1998b).
. Income-increasing accruals preceding IPOs subsequently reverse following
the IPO (Teoh et al., 1998).
. Earnings are adjusted upward to meet analysts’ forecasts (Burgstahler and
Eames, 1998).
Although the evidence discussed above suggests that earnings are managed in the
relatively highly-regulated US environment, a more complete picture forms when
earnings management is examined in an environment relatively uncontaminated by
legal restrictions, enforcement and sanctions. A possible interpretation of observing
Danish managers’ actions is the implication that American managers might act the
same way if they existed in a setting without the legal implications of the American
business environment.
Magnan and Cormier (1997) examine Canadian IPO firms and reveal evidence
that managers apparently exercise discretionary accruals in order to reach
voluntarily disclosed earnings forecasts. They report that Canadian firms increase
(reduce) reported earnings through earnings management if their firm’s sales
activity is lower (higher) than expected. In contrast, the present study recognizes
that earnings, and not sales alone, are widely recognized as the critical activity
measure. We therefore partition firms into over- and underperforming groups based
on the relationship between pre-managed earnings and forecasted earnings. The
objective is to examine discretionary accruals related to a possible incentive to
reach voluntarily specified earnings forecasts. Thus, our first hypothesis is:
H1: If earnings before discretionary accruals differ from management’s

forecast of earnings management will select discretionary accruals that
reduce this difference.
Intuitively, it makes sense to identify firms’ accrual incentives by comparing

pre-managed earnings with earnings forecasts. Firms that fall short of earnings
targets have incentives to increase income and firms that surpass earnings targets
have incentives to decrease income. However, as Gramlich (1992) points out, and
as further discussed in Choi et al. (2001), a serious problem arises if pre-managed
earnings are determined by removing an estimation of discretionary accruals
from reported earnings. The issue arises if the discretionary accrual measure is
used both to partition firms and to measure their accrual response. In such a case,
if random errors occur in estimating discretionary accruals, an erroneously
estimated discretionary accrual can cause a firm to be identified as likely to

engage in certain accrual behaviour, and the same erroneous discretionary
accrual confirms this prediction when it measures the accrual response. In effect,
it is possible that a mechanical relationship between the independent and
dependent variables causes the results to occur as hypothesized. Note, however,
that if discretionary accruals are measured without error, the issue is mute and the
results will be correctly reported. Unfortunately, the evidence suggests that
discretionary accruals can only be measured to a reasonable degree of accuracy
and substantial room exists for improvement (Dechow et al., 1995; Guay et al.,
1996; Young, 1999).
In order to avoid the possibility of incurring problems associated with the
mechanical effect, we also employ the more indirect approach offered by Magnan
and Cormier. This method partitions the sample based on the direction and extent
that reported sales differ from expected sales. If actual sales activity is greater
(less) than expected, we expect that managers will attempt to make up for this
deficiency by engaging in income-decreasing (increasing) accrual behaviour. To
examine the relationship between accruals and manager activity forecasts, we
therefore test the second hypothesis:
H2: If sales are higher (lower) than management’s sales forecast, management
will select discretionary accruals that decrease (increase) reported net
income.
Although the approach employed in H2 attempts to remove all manager

discretion from the partitioning variable, it should be noted that reported sales
also is subject to discretionary accruals. Thus, we are unable to completely
remove measurement error, and the measurement error that remains could cause
spurious results.
In contrast with the contracting literature described earlier, ad hoc evidence
supports the mechanistic or naı̈ve investor hypothesis whereby managers are
expected to prefer to report higher earnings (see, for example, Staley, 1997).
Under this hypothesis, managers believe that increases in reported earnings
positively impact stock prices and that increased stock prices (1) augment
manager wealth, (2) reduce equity capital costs and/or (3) decrease the likelihood
of management job displacement. Although earlier research has examined this
hypothesis, little supporting empirical evidence has been found (Collins et al.,
1981). Kasznik’s (1999) finding, however, supports the view that managers
exercise income-increasing discretionary accruals to reach voluntarily released
forecasts but they do not utilize income-decreasing accruals for the same purpose.
Kasznik suggests that this result may be due to higher litigation costs facing
overestimating American firms relative to firms that underestimate earnings in
their forecasts. This is also consistent with practitioners’ frequent reminders of
the importance of increasing reported earnings. Hence, the third hypothesis,
which only applies if H1 is rejected, follows:
H3: Managers will exercise income-increasing discretionary accruals

regardless of whether pre-managed earnings are above or below forecast
earnings.
The next section discusses the approach we employ to examine managers’

discretionary accruals in response to these implicit contracts.
3. Methodology
Sample Selection
The original sample consists of all domestic Danish operating firms that initially
offered equity shares to the public between January 1984 and December 1996.
Prospectuses for these firms are provided to us by Account Data DK.6 Inclusion
in the final sample requires that management forecast net income for the first
year-end that follows the IPO (denoted year 0).7 Management forecasts are
determined by reading the IPO prospectuses and firms are excluded if they do not
report financial results for at least two full years prior to the IPO (i.e. years 21
and 22). This requirement assures that adequate data exist for the accruals test.
Application of these criteria trims the final sample to 58 domestic Danish
operating firms that reveal voluntary forecasts of net income and 55 firms that
reveal voluntary forecasts of both net income and sales. Table 1 summarizes the
sample selection process.
Table 1. Sample selection procedure for identifying 58 income-forecasting Danish firms

issuing IPOs between 1984 and 1996
Original sample of Danish operating firms consummating IPOs between 101

January 1984 and December 1996
Less: Firms choosing not to forecast post-IPO financial results (15)
Equals: Firms that forecast either a point estimate or a range of earnings 86
before interest and taxes (EBIT ), earnings before taxes (EBT) or net
incomea
Less: Firms that forecast either earnings before interest and taxes or earnings (13)
before taxes, but not net income
Equals: Firms that forecast net income 73
Less: Firms that are excluded because of the lack of sufficient data necessary (15)
to estimate discretionary accruals
Equals: Sample of Danish firms issuing IPOs between 1984 and 1996 that 58
released management forecasts of post-IPO earnings
Less: Firms that did not release forecasts of post-IPO sales (3)
Equals: Sample of Danish firms issuing IPOs between 1984 and 1996 that 55
released management forecasts of post-IPO earnings and sales
a
In the case of a management forecasted range of income or sales, the midpoint of the range is
assumed to be the point estimate for the purpose of the statistical tests that follow.
The table shows that earnings forecasts in IPO prospectuses are quite common in
Denmark. Of the 101 IPOs that occurred during this time period, 86 include a
forecast of earnings before interest and taxes, earnings before taxes, or net income.
Among these 86 forecasters, only 73 forecast the variable of interest, net income.
The final sample is reduced further to 58 (55) as a result of insufficient data for
computing the accrual (and sales) measures.
Variable Definitions
Firms are hypothesized to report greater accruals when earnings before the
discretionary accrual adjustment differ significantly from management’s earnings
forecast. For this purpose, ‘management income forecast error’ (MIFE) is defined
as the difference between earnings before the discretionary accrual adjustment

and management’s earnings forecast:
MIFE0, j ¼ (NI0, j DAC0, j ) MF0, j (1)
where NI0, j is reported net income, DAC0, j is the discretionary accrual, and MF0, j
is management’s earnings forecast for IPO firm j in the IPO year (denoted year 0);
each variable is deflated by the respective firm’s total assets at the beginning of
year 0. According to the equation, a positive (negative) MIFE indicates that pre-
managed earnings are greater (less) than management’s forecast. In other words,
firms with positive (negative) MIFEs may be viewed as ‘overachievers’
(‘underachievers’) relative to their earnings forecast. Note that MIFE is
determined in much the same manner as the variable DAP in the Boynton et al.
(1992) study of discretionary accruals in response to the imposition of a tax on
financially-reported pre-tax income.
In order to test H2, we also partition the 55 firms that forecast both earnings and
sales based on the relationship between actual and predicted sales levels:
MSFE0, j ¼ (SALES0, j FSALES0, j )=FSALES0, j (2)
where SALES0, j is reported net sales and FSALES0, j is forecasted net sales for
IPO firm j in fiscal year 0. A positive MSFE indicates sales activity exceeding
management forecast. Firms indicating positive (negative) MSFE values are
expected to be in pre-accrual income positions whereby income-decreasing
(income-increasing) accruals are necessary to reach the earnings target set forth
by management.
Estimation of Discretionary Accruals

We measure discretionary accruals using the Healy (1985) model to compare a
firm’s accruals in a test period with accruals from an earlier benchmark period.
The discretionary accrual (DAC0, j) for firm j is estimated by subtracting the
expected normal accrual (E(ACj)) from the total accrual in year 0 (AC0, j):
DAC0, j ¼ ½AC0, j E(AC0, j ) (3)
The accounting accrual (AC0, j) is defined as net income (NI0, j) less cash flow
from operations (CFO0, j). Expected normal accruals [E(AC0, j)] are estimated
using a two-year firm-specific average of prior periods’ accounting accruals, or
(AC22, j þ AC21, j)/2.
A number of possible methods are available for estimating discretionary
accruals. For instance, DeAngelo (1986) assumes that the non-discretionary
component of accruals follows a random walk. Thus, DeAngelo estimates the
discretionary accrual as the first difference in total accruals between the test period
and the immediately preceding period. Jones (1991) employs a time-series

approach by regressing total accruals on variables (sales and property, plant and
equipment) that are expected to explain the non-discretionary accruals; the model’s
residual is the estimated discretionary accrual. Boynton et al. (1992) apply a cross-
sectional adaptation of the Jones model using industry peers to estimate the non-
discretionary component of total accruals. DeFond and Jiambalvo (1994) also adapt
a cross-sectional industry-wide approach and allow the coefficients of the
estimating model to vary across years. Dechow et al. (1995) modify the Jones
model by removing the change in receivables from the sales variable used in
estimating accruals. Kasznik (1999) combines the modifications of the Jones model
to estimate discretionary accruals using a model of cross-sectional industry data
applied to cash sales and property plant and equipment, allowing the coefficients of
the variables to vary across years. Although the Jones approach and its subsequent
improvements are conceptually superior, data limitations prevent us from
employing them. Specifically, IPO prospectuses do not provide a sufficient time
series of data to apply the time-series-based Jones model. Further, cross-sectional
comparisons to industry averages are severely hampered by the relatively small
number of securities trading on the Danish stock market. We employ the
Healy model because it requires a minimum time series of data that are especially
appropriate for a study of firms that have undergone IPOs; several sensitivity
analyses are conducted using different accrual measures.
The next section presents the results of our empirical examination to determine
whether voluntary earnings forecast targets influence managers’ discretionary
accruals.
4. Empirical Results Concerning Discretionary Accruals

Descriptive Statistics
Table 2 reports summary statistics for our sample, showing a strong clustering of
IPOs among certain industries and time periods. Panel A indicates that the IPO
firms are concentrated in more mature industries such as metal, machinery and
Table 2. Sample characteristics of Danish firms issuing IPOs between 1984 and 1996
Firms forecasting net Firms forecasting both

income only net income and sales
ISIC Number of Per cent of Number Per cent

codea firms sample of firms of sample
Industry
Panel A: Industry membership
Mining and quarrying 200 1 1.7 1 1.8
Food manufacturing 311 1 1.7 1 1.8
Beverages 313 1 1.7 1 1.8
Textiles 321 3 5.2 3 5.5
Apparel and fur 331 1 1.7 1 1.8
Wood manufacturing 332 2 3.5 2 3.6

Printing and publishing 342 1 1.7 1 1.8
Chemical raw materials 351 3 5.2 2 3.6
Other chemical products 352 1 1.7 1 1.8
Plastic products 356 1 1.7 1 1.8
Bricks, cement and concrete 369 2 3.4 2 3.6
Basic metals (excluding ships) 381 7 12.1 7 12.7
Machinery and equipment 382 9 15.5 9 16.4
Electrical equipment 383 2 3.5 2 3.6
Transportation equipment 384 2 3.5 1 1.8
Instruments and optical equipment 385 2 3.5 2 3.6
Toy manufacturing 390 1 1.7 1 1.8
General contractors 501 2 3.5 2 3.6
Wholesalers 611 9 15.5 9 16.4
Freight transport by road 711 1 1.7 1 1.8
Water transport 712 2 3.5 1 1.8
Other business activities 832 1 1.7 1 1.8
Amusement and recreation services 949 3 5.2 3 5.5
Total sample 58 100.0 55 100.0
Year of IPO
Panel B: Distribution of IPOs across sample years
1984 10 17.2 10 18.2
1985 11 18.9 11 20.0
1986 21 36.2 20 36.4
1987 4 6.9 4 7.3
1988 3 5.2 3 5.5
1989 2 3.5 2 3.6
1990 1 1.7 0 0.0
1991 1 1.7 1 1.8
1992 2 3.5 2 3.6
1993 0 0.0 0 0.0
1994 1 1.7 0 0.0
1995 2 3.5 2 3.6
1996 0 0.0 0 0.0
Totals 58 100.0 55 100.0
a
ISIC is the International Standard Industrial Classification system for categorizing firms within
industries.
wholesale, which constitute approximately 43% of the sample. This is consistent

with other European IPOs which, in contrast with American IPOs, tend to be
consummated by older, established firms for reasons other than financing growth
(Högholm and Rydqvist, 1995). Most popular among the issue years were 1984,
1985 and 1986, with the 42 IPOs during these three years comprising more than
72% of the sample (Panel B). The period 1984– 86 was characterized by high
first-day returns and high volumes which may have resulted from the
compounding effects of at least two phenomena: an increased attention on
stocks by both firms and investors and the presence of a small capitalization stock
exchange. While the IPOs occur more heavily in mature industries during the
years 1984 to 1986, there is no reason to believe that this weighting does not
fairly reflect the Danish economy or to foresee that such weighting would impact
the accruals of IPO firms.
Univariate Statistics
Table 3 presents univariate statistics for the entire sample and for its partitions
based upon the signs of MIFE (Panel A) and MSFE (Panel B). Overall, as of the
balance sheet date immediately following the IPO, the market value of equity for
the typical firm in the sample is approximately 242.41 million DKr and the book-
to-market ratio averages 0.629. Panel A (Panel B) partitions the sample into two
groups, those with positive MIFE (MSFE) and those with negative MIFE
(MSFE). As mentioned earlier, the pressures placed on management to
manipulate earnings are hypothesized to differ depending on whether the forecast
error is positive (i.e. MIFE . 0 or MSFE . 0) or negative (i.e. MIFE , 0 or
MSFE , 0). In other words, firms with positive (negative) MIFE or MSFE are
expected to employ income-decreasing (income-increasing) discretionary
accruals to reach their earnings forecasts.
Table 3, Panel A, reports that firms with positive MIFEs do not differ
statistically from firms with negative MIFEs on many dimensions, indicating that
the sample partitions appear alike in many respects other than the fact that one
overachieves relative to its management earnings forecast while the other
underachieves. The two groups are not different at statistically significant levels
with respect to the market value of outstanding equity, the book-to-market ratio,
the ratio of net income to total assets, the ratio of management’s earnings forecast
to beginning-of-year total assets, or the number of days between management’s
forecast declaration and the first year-end after the IPO. Although not statistically
significant, firms with negative MIFE tend to be valued less by the stock market,
earn less income relative to total assets, and forecast higher profit than firms with
positive MIFE. The striking differences relate to MIFE and DAC. It comes as no
surprise that MIFE is statistically different between the groups since it is the
variable used to partition the sample. Both mean and median DAC, however, are
also significantly different. As predicted by H1, on average, firms with higher pre-
managed earnings, relative to forecast earnings, indicate greater income-
246
J. D. Gramlich and O. Sørensen

Table 3. Variable definitions and univariate statistics by sign of partitioning variable (amounts are in millions of Danish kroner unless otherwise
specified)
Statistical tests for
differences in means and
medians between the
Complete sample MIFE 0 (n ¼ 27) MIFE , 0 (n ¼ 31) MIFE 0 and MIFE , 0
(n ¼ 58) (‘overachievers’) (‘underachievers’) groups
Mean Mean Mean t-statisticb z-statisticc

Variable definition (std dev.) Median (std dev.) Median (std dev.) Median (p-value) (p-value)
Panel A: Partitions based on sign of management income forecast error (MIFE)a

MV – Market value of outstanding equity 242.41 112.91 253.30 121.00 232.93 90.00 0.210 0.966
(366.26) (295.79) (422.91) (0.835) (0.334)
B/M – Book-to-market value 0.629 0.574 0.632 0.581 0.628 0.497 0.054 0.530
(0.266) (0.218) (0.304) (0.957) (0.596)
NITA– Net income deflated by 0.068 0.087 0.099 0.090 0.040 0.083 1.328 0.904
beginning-of-year total assets (0.181) (0.048) (0.243) (0.193) (0.366)
MIF– Management forecast of net 0.103 0.096 0.094 0.088 0.111 0.103 21.284 21.154
income deflated by beginning-of-year (0.049) (0.042) (0.054) (0.204) (0.249)
total assets
MIFE –Management income forecast 20.037 20.002 0.133 0.071 20.185 20.103 24.535 26.516
errora (0.310) (0.243) (0.287) (0.0000) (0.0001)
DAC–Current year accrual minus the 0.001 0.011 20.129 20.071 0.115 0.088 24.887 26.438
Voluntary Management Earnings Forecasts and Discretionary Accruals

average of the prior two years’ accruals (0.217) (0.237) (0.111) (0.0001) (0.0001)
(accrual is defined as net income minus
cash flows from operations)

Days– Number of days between 238.38 251.00 228.15 245.00 247.29 260.00 20.897 20.974
management’s forecast declaration (80.96) (82.03) (80.27) (0.3737) (0.330)
and the first year-end after the IPO
CFO/MF – Ratio of cash flows from 1.412 1.034 3.336 1.800 20.264 0.321 2.790 5.892
operations to management’s forecast (5.184) (6.540) (2.784) (0.007) (0.000)
of net income
(continued)
247
248
J. D. Gramlich and O. Sørensen

Table 3. Continued.
Statistical tests for
differences in means and
medians between the
Complete sample MSFE 0 (n ¼ 25) MSFE , 0 (n ¼ 30) MSFE 0 and MSFE , 0
(n ¼ 55) (‘overachievers’) (‘underachievers’) groups
Mean Mean Mean t-statisticb z-statisticc

Variable definition (std dev.) Median (std dev.) Median (std dev.) Median (p-value) (p-value)
d
Panel B: Partitions based on sign of management sales forecast error (MSFE)
MV – Market value of outstanding equity 219.56 99.60 160.50 82.94 268.77 120.75 21.194 20.718
(358.94) (183.05) (454.60) (0.240) (0.473)
B/M – Book-to-market value 0.614 0.570 0.662 0.600 0.574 0.525 1.237 1.209
(0.263) (0.262) (0.261) (0.222) (0.227)
NITA– Net income deflated by 0.064 0.086 0.096 0.090 0.037 0.074 1.300 1.073
beginning-of-year total assets (0.185) (0.041) (0.246) (0.204) (0.283)
SALES –Reported net sales 308.78 138.85 341.57 147.50 281.45 132.79 0.533 0.904
(414.03) (443.94) (392.93) (0.597) (0.366)
FSALES – Management sales forecast 314.30 138.70 327.99 135.00 302.89 140.60 0.220 20.254
(417.90) (435.89) (409.45) (0.827) (0.800)
MSFE – Management sales forecast 20.052 20.008 0.063 0.063 20.147 20.056 5.814 6.330
error (reported sales minus forecast (0.178) (0.056) (0.188) (0.0001) (0.0001)
sales, divided by forecast sales)
Voluntary Management Earnings Forecasts and Discretionary Accruals
DAC – Current year accrual minus the 0.027 0.025 0.001 20.003 0.049 0.057 21.334 21.428
average of the prior two years’ (0.142) (0.080) (0.177) (0.189) (0.153)
accruals (accrual is defined as net
income minus cash flows from

operations)
Days– Number of days between 239.71 251.00 244.88 249.00 235.40 255.50 0.425 20.025 (0.980)
management’s forecast declaration (81.77) (77.96) (85.89) (0.673)
and the first year-end after the IPO
CFO/MF – Ratio of cash flows from 0.762 0.948 1.324 1.362 0.294 0.847 1.660 1.479 (0.139)
operations to management’s forecast (2.481) (1.280) (3.000) (0.105)
of net income

Indicates statistically significant differences at the 0.001 level.
a
MIFE is the difference between earnings before the discretionary accrual adjustment and management’s earnings forecast:
MIFE0, j ¼ (NI0, j DAC0, j ) MF0, j
where NI0, j is reported net income, DAC0, j is the discretionary accrual, and MF is management’s earnings forecast for IPO firm j in the IPO year (denoted year 0); each
variable is deflated by the respective firm’s total assets at the beginning of year 0.
b
p-values for the t-tests report the probability that the compared means are equal to one another (two-tailed). The reported t-statistics and p-values reflect equal
variances between the two sample distributions unless an F-test indicates that the variances are unequal (at the 0.05 significance level), in which case the t-statistics and
p-values are reported assuming unequal variances.
c
p-values for the median comparisons are from two-tailed Wilcoxon sign rank tests of the null hypothesis that the medians are equal.
d
MSFE is the difference between actual and forecast sales, deflated by forecast sales:
MSFE0, j ¼ (SALES0, j FSALES0, j )=FSALES0, j
where SALES is reported net sales and FSALES is forecasted net sales for IPO firm j in fiscal year 0.
249
Table 4. Comparison of means (medians) of discretionary accruals (DAC )a for extreme

groups determined by ranking management income forecast errors (MIFE )b and
management sales forecast errors (MSFE )c
Significance level
of difference
between lowest
and highest
Partitions Group 1 Group 2 Group 3 Group 4 Group 5 groupsd
Panel A: Partitions of management income forecast error (MIFE)b from lowest

(‘underachievers’) to highest (‘overachievers’)
Halves e
MIFE lower bound 21.497 20.002
MIFE upper bound 20.002 1.242
Mean DAC 0.122 20.119 0.000

Median DAC 0.100 20.070 0.000
Number of obs. 29 29
Thirds e
MIFE lower bound 21.497 20.078 0.047
MIFE upper bound 20.078 0.043 1.242
Mean DAC 0.157 0.016 20.169 0.000
Median DAC 0.127 0.011 20.090 0.000
Number of obs. 19 20 19
Quartiles e
MIFE lower bound 21.497 20.104 20.002 0.071
MIFE upper bound 20.108 20.002 0.064 1.242
Mean DAC 0.179 0.069 20.030 20.214 0.000
Median DAC 0.140 0.068 20.034 20.120 0.000
Number of obs. 14 15 15 14
Quintiles e
MIFE lower bound 21.497 20.117 20.051 0.018 0.076
MIFE upper bound 20.128 20.058 0.017 0.016 1.242
Mean DAC 0.197 0.091 0.012 20.048 20.249 0.000
Median DAC 0.155 0.083 0.011 20.044 20.130 0.000
Number of obs. 11 12 12 12 11
Panel B: Partitions of management sales forecast error (MSFE)c from lowest

(‘underachievers’) to highest (‘overachievers’)
Halves e
MSFE lower bound 20.773 20.008
MSFE upper bound 20.011 0.237
Mean DAC 0.055 0.001 0.086
Median DAC 0.065 20.008 0.139
Number of obs. 27 28
Thirds e
MSFE lower bound 20.773 20.042 0.025
MSFE upper bound 20.043 0.018 0.237
Mean DAC 0.080 0.009 20.006 0.053
Median DAC 0.073 20.018 20.002 0.019
Number of obs. 18 19 18
Table 4. Continued.
Significance level
of difference
between lowest
and highest
Partitions Group 1 Group 2 Group 3 Group 4 Group 5 groupsd
Quartiles e
MSFE lower bound 20.773 20.060 20.008 0.050
MSFE upper bound 20.087 20.011 0.037 0.237
Mean DAC 0.097 0.015 0.009 20.007 0.074
Median DAC 0.119 0.021 20.016 20.002 0.108
Number of obs. 13 14 14 14
Quintiles e
MSFE lower bound 20.773 20.092 20.029 0.010 0.070
MSFE upper bound 20.095 20.033 0.006 0.066 0.237
Mean DAC 0.115 0.004 0.022 0.003 20.007 0.072
Median DAC 0.139 20.008 0.034 20.003 20.013 0.018
Number of obs. 11 11 11 11 11
a
DAC (discretionary accruals) equals the current year accrual minus the average of the prior two
years’ accruals (accrual is defined as net income minus cash flows from operations).
b
MIFE is the difference between earnings before the discretionary accrual adjustment and
management’s earnings forecast:
where NI0, j is reported net income, DAC0, j is the discretionary accrual, and MF is management’s
earnings forecast for IPO firm j in the IPO year (denoted year 0); each variable is deflated by the
respective firm’s total assets at the beginning of year 0.
c
MSFE is the difference between actual and forecasted sales, deflated by forecast sales:
d
p-values for comparisons of means are from two-tailed t-tests of the null hypothesis that the means
equal one another. p-values for comparisons of medians are from two-tailed Wilcoxon sign rank tests
of the null hypothesis that the medians are equal.
e
Panel A (B) ranks firms in ascending order based on MIFE (MSFE). Using this ranking, the sample is
partitioned into two, three, four and five groups of equal sizes, applying the SAS statement
GROUP ¼ (e.g., GROUP ¼ 3). When the number of firms in the sample is not evenly divisible by the
number of groups specified, SAS first allocates the remainder to the middle partition, then to the
partition immediately following the middle partition, and so forth until all of the remainder is allocated
to the partitions.
decreasing (or lesser income-increasing) discretionary accruals than firms with

lower pre-managed earnings (p ¼ 0.0001).8
Firms are partitioned on the basis of MSFE in Table 3, Panel B. Although the
means and medians of DAC differ in the predicted directions, the statistical
significance of the differences disappears when MSFE is the partitioning variable.
One possible interpretation is that some of the difference identified by

partitioning MIFE results from the mechanical effect of random errors in
estimating discretionary accruals that was discussed earlier. Another possibility
is that MSFE is not a strong predictor of management’s pre-accrual position with
respect to forecast net income. Further analysis is necessary.
Comparisons of Extreme Groups

Table 4 compares sample DAC measures for the extreme groups of halves,
thirds, quartiles and quintiles based on rankings of MIFE (Panel A) and
MSFE (Panel B).9 Consistent with Table 3, Panel A, when firms are ranked
by MIFE, the differences in DAC between the extreme groups differ in the
predicted direction at highly significant levels. These differences are significant

using both the parametric t-test and the non-parametric Wilcoxon one-tail sign
rank tests.10
When extreme groups are formulated by ranking MSFE (Table 4, Panel B), the
differences are not as extreme as they are when using the MIFE approach. In
Table 3, Panel B, partitions based on the sign of MSFE produce 30 firms with
MSFE , 0 and 25 firms with MSFE 0. However, partitioning the same group
into halves in Table 4, Panel B, produces a slightly different mix: one group of 27
and another of 28. The difference in mean discretionary accruals between the
groups, however, becomes statistically significant when the firms are partitioned
into halves rather than when they are partitioned based on the sign of MSFE (one-
tail p , 0.043). Apparently, the two firms with the least negative values of MSFE
are critical; they report enough less income-increasing (or more income-
decreasing) accruals so that when they are grouped with positive MSFE firms
the difference in mean discretionary accruals becomes statistically significant. At
the 0.05 significance level (one-tail), all of the differences in means shown on
Panel B are statistically significant, as predicted. In addition, the differences in
medians are also significant in comparing the extreme thirds and quintiles. Only
the medians of the halves and the quartiles are not statistically different, although
they are nearly so. Thus, the figures shown in Table 4, Panel B, generally indicate
statistical significance in the differences based on MSFE. The evidence indicates
moderately strong support for the view that Danish managers exercise
discretionary accruals to reach voluntary earnings forecasts revealed in
conjunction with IPOs.
Sensitivity Analyses
Table 5 reports the results of conducting additional tests using alternative
dependent variables and including an alternative activity measure. Panel A shows
the primary results when the discretionary accrual measure follows DeAngelo’s
(1986) definition (i.e. the current-year accrual, ACt, less the prior-year accrual,
ACt21). Using the DeAngelo measure and the MIFE activity measure, mean and
Table 5. Sensitivity analyses using alternative accrual measures
Means (standard deviations) and [medians]

for these groups:
Complete Over- Under- Significance

Variable definition sample achievers Achievers test p-valuesc
Panel A: DeAngelo accrual

Activity measure: pre-managed earnings
MIFE –Management income 20.030 0.199 20.180 0.000
forecast errora (0.353) (0.334) (0.279)
[20.021] [0.114] [20.101] 0.000
DAC – Current year accrual 20.006 20.194 0.118 0.000
minus the prior year (0.274) (0.328) (0.127)

accrual (accrual is defined [0.031] [20.112] [0.095] 0.000
as net income minus cash
flows from operations)
CFO/MF – Ratio of cash 1.412 3.659 20.065 0.023
flows from operations to (5.184) (7.056) (2.687)
management’s forecast of [1.034] [2.041] [0.566] 0.000
net income
Activity measure: sales

MSFE – Management sales 20.052 0.063 20.147 0.000
forecast errorb (0.178) (0.056) (0.188)
[20.008] [0.063] [20.056] 0.000
net income
Panel B: Raw accrual

Activity measure: pre-managed earnings
MIFE –Management income 20.013 0.132 20.167 0.000
forecast errora (0.302) (0.225) (0.300)
[0.003] [0.085] [20.063] 0.000
(continued)
Table 5. Continued
Means (standard deviations) and [medians]
for these groups:
Complete Over- Under- Significance

Variable definition sample achievers Achievers test p-valuesc

net income
Activity measure: sales

MSFE – Management sales 20.052 0.063 20.147 0.000
forecast errorb (0.178) (0.056) (0.188)

[20.008] [0.063] [20.056] 0.000
net income
a
MIFE is the difference between earnings before the discretionary accrual adjustment and
management’s earnings forecast:
where NI0, j is reported net income, DAC0, j is the discretionary accrual, and MF is management’s
earnings forecast for IPO firm j in the IPO year (denoted year 0); each variable is deflated by the
respective firm’s total assets at the beginning of year 0.
b
MSFE is the difference between actual and forecasted sales, deflated by forecast sales:
c
p-values for comparisons of means are from two-tailed t-tests of the null hypothesis that the means
equal one another. p-values for comparisons of medians are from two-tailed Wilcoxon sign rank tests
of the null hypothesis that the medians are equal.
median discretionary accruals are significantly more negative (and less positive)
for overachievers compared with underachievers (p , 0.00). MIFE as an activity
measure is validated by the significantly larger ratio of cash flows from
operations to management income forecast (CFO/MF ) among overachievers
relative to underachievers. Consistent with the earlier tests, when activity level is
measured by MSFE, the significant difference in discretionary accruals
disappears (p , 0.277). MSFE also appears to be less valid as an activity

measure since the difference in mean CFO/MF also dissipates (p , 0.105).
Panel B reports the results using the raw accrual, net income less cash flows
from operations, as the dependent variable. The underlying assumption with this
measure is that, ceteris paribus, the accrual should equal zero. The results using
raw accruals are consistent with those reported in the primary tests (Table 3) and
in Panel A; the significant differences using the MIFE activity measure disappear
when the MSFE measure is employed. Note that the CFO/MF figures exhibited
to validate the activity measure are the same in Panels A and B. Overall, the
results of the sensitivity analysis are consistent with the basic finding of earnings
management to reach earnings forecast targets.
In other tests (not reported in the tables) we applied simple linear regression
models (4) and (5) to our data:
DAC0, j ¼ g0 þ g1 MIFE0, j þ j (4)
DAC0, j ¼ g0 þ g1 MSFE0, j þ j (5)
The analysis would support the assertion that positive (negative) management
forecast errors are related to negative (positive) discretionary accruals if the sign
of the independent variable is negative and significant. The results of these
analyses are highly consistent with those presented in Tables 3, 4 and 5.
Specifically, the coefficient of MIFE is negative and significant (one-tail
p-value , 0.0001) and the coefficient of MSFE is negative but insignificant
(one-tail p-value ¼ 0.1053). Thus, MIFE effectively discriminates the entire
sample of DAC values but, as Table 4 demonstrates, MSFE is only effective
in obtaining significant differences in DAC when the sample is parsed to include
only the extreme values of MSFE. Interestingly, when the regression analyses are
run separately for positive and negative forecast errors, the positive forecast error
groups tend to have larger negative coefficients. However, both positive and
negative MIFE groups are negatively related to DAC (p , 0.0001) while neither
positive nor negative MSFE groups are significantly tied to DAC.
5. Discussion and Conclusion

Securities regulations in Denmark allow firms issuing shares through IPOs to
include earnings forecasts in their prospectuses. In fact, during our 13-year sample
period, 85% of Danish firms undergoing IPOs voluntarily released management
earnings forecasts. This study is made possible by the willingness of Danish
managers to release such forecasts, since American IPO firms rarely issue earnings
forecasts. Although this study cannot be generalized beyond Danish firms, a review
of these results in conjunction with American studies allows a suggestion of the
influence of American litigation costs facing managers. In other words, how might
American managers act if not for the potentially high litigation costs?
The dual purposes of this paper are to determine (1) whether Danish managers
view management earnings forecasts as terms of an implicit contract with
shareholders, and (2) if these managers exercise discretionary accruals to reach these
earnings targets. If a forecast is deemed to be an implicit contract between a firm’s
managers and investors, with direct and indirect costs imposed on managers who do
not comply with its terms, we hypothesize that managers will purposefully engage in
accrual management to minimize the gap between reported and forecast earnings.
The evidence strongly suggests that Danish IPO firms engage in accruals
management to reach their voluntary earnings forecast targets. The direction and
extent of the accrual management depends on how both pre-managed earnings and
actual sales levels differ from forecast levels. Firms reduce (increase) reported
earnings through earnings management depending on whether pre-managed
earnings and actual sales are higher (lower) than forecast levels. This systematic
finding lends credence to the hypothesis that managers view earnings forecast
numbers as terms of an implicit contract. The evidence also supports the second
hypothesis that discretionary accruals are made to reduce forecast error, without
regard to whether pre-managed earnings are greater or less than their target forecast.
Thus, to the extent that the Dutta and Gigler (2002) analysis applies to implicit as
well as explicit contracts, the evidence suggests that the Danish contractual setting
may be less optimal than one in which managers are rewarded for reaching high
targets but not penalized for over-shooting low targets.
In summary, in an environment without high potential litigation costs, Danish
firms undergoing IPOs often voluntarily forecast post-IPO sales and earnings.
Discretionary accruals (or ‘earnings management’) appear to be used to narrow
the gap between forecast and reported earnings, and this suggests that managers
view voluntary earnings forecasts as terms of an implicit contract with
stakeholders. Thus, Danish managers typically provide more earnings forecasts,
they view these forecasts as terms of implicit contracts, and they appear to
possess the flexibility to manage earnings to reach the forecasts.
This study examines earnings management in response to IPO-related earnings
forecasts that have been voluntarily released to investors by Danish managers.
The IPO setting was chosen because, ceteris paribus, the lack of prior
information about the firm is likely to force investors to place greater relative
information value on such forecasts than they would for existing public
companies. However, to the extent that Danish listed companies ordinarily
release earnings forecasts, the empirical issue remains unanswered as to whether,
and to what extent, managers window dress their earnings to reach these targets.
We look forward to further research that examines this and other related issues.
Notes
1. Under regulations related to the Securities Acts of 1933 and 1934 (including rules
10b-5 and 10b-6), the initial measure of damages is usually determined by the stock
price decline from the offering date to the date of the suit. Plaintiffs in such cases are
not required to show that they relied on the earnings forecast, and the burden is on
the defence to demonstrate that the earnings forecast was reasonable and that the
stock price decline was due to factors beyond management’s control.
2. Singapore is an example where it is mandatory that managers release a forecast of
post-IPO earnings at the time of the IPO (see Firth, 1998).
3. Multex.com currently reports more than 9,000 public US firms.
4. Note that the information role of management earnings forecasts may be tempered
by the uncertainty associated with the lack of reputation among IPO managers
relative to the reputations of managers of existing public companies.
5. One objective of earnings management research is to offer suggestions for standard
setters. See Healy and Wahlen (1999) for a review of this literature and its
prescriptions for regulators.
6. Maintained by the Department of Accounting and Auditing at Copenhagen Business
School, Account Data DK is a comprehensive standardized database of financial
statement and security price information for all public corporations incorporated in
Denmark and traded on the Copenhagen Stock Exchange.

7. The estimate of net income provided by management is either a point estimate or a
range. In the one case of a range, we choose the midpoint as the point estimate.
Firms that report only qualitative, open-ended or one-sided forecasts (e.g. net
income will be ‘at least’ or ‘at the most’ some given value) are excluded from the
sample.
8. Note, however, that the mean accruals of neither the overachievers nor the
underachievers are significantly different from zero. This non-significance may be
due to the relatively small sample size, less than perfect classification using the
MIFE independent variable, measurement problems with DAC, or macroeconomic
conditions which may cause the mean non-discretionary component of accruals to
be non-zero.
9. The groups are determined using the SAS statement GROUPS ¼ 2, 3, 4 and 5 for
halves, thirds, quartiles and quintiles, respectively. When the sample is not evenly
divisible, the SAS algorithm is to allocate extra observations to the middle group
first, the middle-right group second, the middle-left group third, etc. (to explain the
seemingly arbitrary assignment of firms among groups).
10. Tables 3, 4 and 5 present statistical comparisons using two-tail parametric and non-
parametric tests because several of the comparisons are for descriptive items for
which the direction of the difference is not predicted. However, since the direction
of the DAC difference is predicted (i.e. to bring reported income toward
management’s earnings forecast), we discuss tests with respect to DAC as one-tail
tests although they are reported as two-tailed tests. In other words, two-tail p-values
are divided by two to reach the one-tail p-values.
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Voluntary Management Earnings

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On: 30 June 2013, At: 18:51

European Accounting Review

Voluntary management earnings

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Voluntary Management Earnings Forecasts

JEFFREY D. GRAMLICH AND OLE SØRENSEN

(Received August 2001; accepted September 2003)

ABSTRACT This paper seeks to determine whether Danish managers exercise

Correspondence Address: Jeffrey Gramlich, L. L. Bean/Lee Surace Professor of

0963-8180 Print/1468-4497 Online/04/020235-25 # 2004 European Accounting Association

management. They analytically determine that the benefit of receiving earnings

little pre-IPO information is available to external investors; managers therefore

2. Literature Review, Motivation and Hypothesis Development

credible information (Verrecchia, 1983; Diamond, 1985; Trueman, 1986; Fishman

. Managers choose income-increasing accruals prior to IPOs (Friedlan, 1994; Teoh

H1: If earnings before discretionary accruals differ from management’s

Intuitively, it makes sense to identify firms’ accrual incentives by comparing

estimated discretionary accrual can cause a firm to be identified as likely to

Although the approach employed in H2 attempts to remove all manager

H3: Managers will exercise income-increasing discretionary accruals

The next section discusses the approach we employ to examine managers’

Table 1. Sample selection procedure for identifying 58 income-forecasting Danish firms

Original sample of Danish operating firms consummating IPOs between 101

as the difference between earnings before the discretionary accrual adjustment

MIFE0, j ¼ (NI0, j DAC0, j ) MF0, j (1)

MSFE0, j ¼ (SALES0, j FSALES0, j )=FSALES0, j (2)

Estimation of Discretionary Accruals

DAC0, j ¼ ½AC0, j E(AC0, j ) (3)

and the immediately preceding period. Jones (1991) employs a time-series

4. Empirical Results Concerning Discretionary Accruals

Firms forecasting net Firms forecasting both

ISIC Number of Per cent of Number Per cent

Wood manufacturing 332 2 3.5 2 3.6

wholesale, which constitute approximately 43% of the sample. This is consistent

the accruals of IPO firms.

J. D. Gramlich and O. Sørensen

Mean Mean Mean t-statisticb z-statisticc

Panel A: Partitions based on sign of management income forecast error (MIFE)a

Voluntary Management Earnings Forecasts and Discretionary Accruals

cash flows from operations)

J. D. Gramlich and O. Sørensen

Mean Mean Mean t-statisticb z-statisticc

income minus cash flows from

MIFE0, j ¼ (NI0, j DAC0, j ) MF0, j

MSFE0, j ¼ (SALES0, j FSALES0, j )=FSALES0, j

Table 4. Comparison of means (medians) of discretionary accruals (DAC )a for extreme

Panel A: Partitions of management income forecast error (MIFE)b from lowest

Mean DAC 0.122 20.119 0.000

Panel B: Partitions of management sales forecast error (MSFE)c from lowest

MIFE0, j ¼ (NI0, j DAC0, j ) MF0, j

MSFE0, j ¼ (SALES0, j FSALES0, j )=FSALES0, j

decreasing (or lesser income-increasing) discretionary accruals than firms with

One possible interpretation is that some of the difference identified by

Comparisons of Extreme Groups

predicted direction at highly significant levels. These differences are significant

Table 5. Sensitivity analyses using alternative accrual measures

Means (standard deviations) and [medians]

Complete Over- Under- Significance

Panel A: DeAngelo accrual

minus the prior year (0.274) (0.328) (0.127)