Earnings Management and

Overinvestment: Accrual-Based
versus Real Activities

Daniel A. Cohen and Paul Zarowin

New York University

November, 2009
 Purpose of paper
• examine how both real and accrual-based
earnings management activities affect
firms’ investment activities

2
 Motivation
• dearth of evidence on how EM affects
firms’ real activities
• Research on the consequences of EM has
concentrated largely on announcement
and post event stock market returns

3
 Motivation, continued
• earnings management may affect resource allocation by
causing firms to make suboptimal investment decisions
• returns studies can only determine whether securities
are mispriced, which causes redistribution (between
different groups of shareholders), but cannot assess
affects on real firm decisions
• Because they affect the size of the pie, and not just its
distribution, real decisions are likely more costly than
share price effects.

4
 2 recent papers
• Kedia and Philippon, 2008
• McNichols and Stubben, 2008
• Study real effects of EM

5
 Kedia and Philippon, 2008
• SEC mandated restatement sample
• overinvested (excess capexp) and
over hired during the EM period
• subsequently underinvested and shed
employment
• Their hypothesis: manipulating firms invest
and hire excessively to pool with better
performing firms, in order to avoid
detection 6
 McNichols and Stubben 2008
• 3 groups of firms that overstated earnings
• investigated by the SEC for accounting
• sued by their shareholders for accounting
• restated their financial statements
• Overinvested (excess capexp) during the
misreporting period
• underinvested during post-event period
• Their hypothesis: overinvestment is caused by
the misleading signals that the misstated
information sends to both internal decision
makers and external suppliers of capital. 7
 2 recent papers, continued
• Both studies focus exclusively on accrual-
based earnings management
• Small, event-based samples
• Extreme cases of earnings management

8
 Our contribution
1. First study to examine economic
consequences of real EM
2. Large sample, not event-based, not extreme
earnings management: results can be
generalized to wide population of firms

9
 Our findings
• Both real and accrual EM firms overinvest in the
years up to and including the period of high EM,
and then underinvest
• Indicates that EM is associated with significant
real effects
• Real EM firms overinvest more than accrual EM
firms
• first evidence that real EM has important
economic effects

10
 Increased interest in real EM
• Recent increased interest in EM thru real
activities manipulation
• Gunny 2006
• Roychowdhury 2006
• Zang 2006

11
 Increased interest in real EM,
continued
• Graham et al. (2005): managers prefer
real earnings management activities
compared to accrual-based earnings
management.
• Real management activities can be
indistinguishable from optimal business
decisions.
• More difficult to detect.

12
 Increased interest in real EM,
continued
• Cohen et al. (2008): managers have
shifted away from accrual to real earnings
management in the post SOX period.
• Perhaps because of the need to avoid
detection following highly publicized
accounting scandals.

13
 Related Literature –
consequences of EM
• focus on stock price effects related to EM
• EM around specific corporate events:
IPOs, SEOs, management buyouts, stock
repurchases, stock for stock acquisitions
• how ex-ante EM relates to observed post
event abnormal stock returns
• Rangan (1998) and Teoh et al. for SEO’s
• Teoh, Wong, and Rao (1998) for IPOs
14
 Related Literature –
consequences of EM, cont’d
• short-term capital market reactions around
announcements of fraudulent reporting
• Foster (1979), Dechow, Sloan, and
Sweeny (1996), Beneish (1997), and
Palmrose, Richardson, and Scholz (2004)
• market reaction to disclosure of
manipulation is on average negative,
implying that investors were surprised and
interpret these as negative news
15
 Related literature: Studies of real
earnings management
• Graham et al.’s survey (2005) - managers prefer real
activities manipulation, over accruals manipulation, as a
way to manage earnings.

• Several features of real earnings management:

– Involve current or future cash flows
– Cannot be made after the end of the fiscal period
– Tougher to be challenged by auditors

• Managers may favor real EM strategies

– Less regulatory scrutiny
– Earlier actions to safeguard against future potential
accrual shortfalls 16
 Real earnings management, cont’d
• Roychowdhury (2006) - firms try to avoid losses 3
ways:

• (1) boosting sales through accelerating timing

and/or generating additional unsustainable sales
through increased price discounts or more lenient
credit terms

• (2) overproducing and allocating more overhead

to inventory and less to cost of goods sold

• (3) reducing aggregate discretionary expenses

(R&D + advertising+ SG&A) to improve margins.
17
Real earnings management, cont’d
• Zang (2006) - analyzes the tradeoffs between
accrual manipulations and real earnings
management.
• shows that real manipulation is positively
correlated with the costs of accrual manipulation
• accrual and real manipulations are negatively
correlated
• Conclusion: managers treat the two strategies
as substitutes.

18
 Empirical methodology –
Data and Initial Sample
• COMPUSTAT from 1987 to 2006, to use
SFAS No. 95 SCF to estimate accruals,
(Collins and Hribar, 2002)
• all nonfinancial firms with available data
necessary to calculate the discretionary
accruals metrics and real EM proxies for
our analysis
• ≥ 8 observations in each 2-digit SIC
grouping per year
19
• 82,039 firm-year observations
 SUSPECT Firms
• Focus on SUSPECT firms – firms likely to
have managed earnings
• firms with annual earnings before
extraordinary items (scaled by total
assets) between 0 and 0.005
• 3,831 firm-year observations (Table 2,
Panel B - 4.67% of initial sample)

20
 Accrual-based Earnings
Management Metric
• modified cross-sectional Jones model (Jones
1991) as described in Dechow et al. (1995).
• (1)

21
 Accrual model, cont’d
• where, for fiscal year t and firm i, TA represents total
accruals:
• TA it = EBXI it – CFO it,
• EBXI is earnings before extraordinary items and disc.
operations (annual Compustat 123)
• CFO is operating cash flows (from continuing operations)
taken from the statement of cash flows (Compustat 308
– Compustat 124),
• Assetit-1 is total assets (Compustat 6),
• REVit is change in revenues (Compustat 12), and
• PPEit is the gross value of property, plant and
equipment (Compustat 7).
22
 Accrual model, cont’d
• cross-sectional model of discretionary
accruals
• for each year we estimate the model for
every 2-digit SIC code
• control for industry-wide changes in
economic conditions that affect total
accruals
• allows coefficients to vary across time
23
 Accrual model, cont’d
• coefficient estimates from equation (1) are used to
estimate the firm-specific normal accruals (NA it) for our
sample firms:
• (2)

• discretionary accruals is the difference between total

accruals and the fitted normal accruals, defined as:
• DAit = (TA it / Assetit-1) – NAit.
• Accrual based earnings managers: top 10% of firm-year
DA observations each year (8,204 firm-year observations)

24
 Real Earnings Management
Metrics
• Based on Roychowdhury (2006), Zang
(2006) and Gunny (2006)
• 3 metrics as proxies for real earnings
management - abnormal levels of:
• CFO
• discretionary expenses
• production costs

25
 3 real manipulation methods
• 1. Accelerate timing of sales by increased
price discounts or more lenient credit
terms.
• 2. Reporting of lower cost of goods sold
through increased production.
• 3. Decreased discretionary expenses,
such as advertising, R&D, and SG&A
expenses.

26
 Calculation of 3 metrics
• 1. ∆sales > 0 and ∆CFO < 0
• INCR_SALES&DECR_CFO
• 2. ∆COGS < 0 and ∆inventory > 0
• COGS_CUT&∆INV>0
• 3. 0 < EBDISXt < DISXt-1
• can show profits by cutting discretionary
expenditures below last year’s amount

27
 Table 1- Panel A
Sample statistics
• comparison of SUSPECT vs non-
SUSPECT firms
• SUSPECT firms are:
• smaller (in terms of assets, sales, MV)
• less profitable
• Invest more (cap and non-cap exp, %TA)
• greater growth in assets and employees.
• high growth -consistent with Kedia and
Philippon and McNichols and Stubben. 28
 Table 1, Panel A:
Comparison of Investment Activities and Earnings Management Strategies among
Different Group of Firms: SUSPECT vs. NON-SUSPECT Firms
SUSPECT FIRMS NON-SUSPECT DIFF. in
MEAN MEDIAN
MEAN MEDIAN MEAN MEDIAN
(t-stat.) (z-stat.)
INVEST 0.231 0.184 0.143 0.094 0.088 0.090
(5.67) (4.21)
CAPEX 0.364 0.248 0.284 0.173 0.080 0.075
(4.37) (3.64)
NONCAPEX 0.081 0.076 0.046 0.018 0.035 0.058
(3.04) (4.32)
GROW 0.089 0.064 0.064 0.053 0.025 0.011
(4.51) (5.49)
EMPL 0.051 0.042 0.034 0.027 0.017 0.015
(2.86) (2.15)
Total Accruals -91.371 -9.643 -72.39 -6.324 -18.981 -3.319
($Million) (-8.37) (-6.81)
CFO ($Million) 85.694 7.742 152.312 13.264 -66.618 -5.522
(-6.81) (-9.37)
Total Assets 1357.341 264.371 1423.231 176.341 -65.890 88.03
(-5.14) (4.53)

MVE 763.491 86.374 1634.218 203.054 -870.727 -116.68

(-11.37) (-8.17)
Sales 1432.697 267.153 1543.141 295.327 -110.444 -28.174
(-7.68) (-4.06)
ROA 0.031 0.043 0.087 0.064 -0.056 -0.021 29
(-3.16) (-4.67)
 Table 1 - Panel B
sample distribution
• Firms using real earnings management:
• 2,000 – 2,600 observations (2.5% - 3.2%
of initial sample)

30
 Focus: 4 subgroups
• intersection of SUSPECT and earnings
management
• firms likely to have managed earnings
• we can identify the method of earnings
management
• Thus, we can calculate the relation
between the method and the extent of
over- or under investment.
31
 4 subgroups, cont’d
• All 4 subgroups have similar number of
observations (0.8% - 1.0% of sample)
• This gives us confidence that all four
subgroups have comparable degrees of
earnings management

32
 Panel B: Sample Distribution
Number of Firm-Year Observations Percentage (%)
Overall Sample 82,039 100%
SUSPECT 3,831 4.67%
INCR_SALES&DECR_CFO 2,174 2.65%
COGS_CUT&∆INV>0 2,609 3.18%
0 < EBDISXt < DISXt-1 2,043 2.49%
DA 8,204 10%
SUSPECT & 673 0.82%
INCR_SALES&DECR_CFO
SUSPECT & COGS_CUT&∆INV>0 796 0.97%
SUSPECT & 0 < EBDISXt < DISXt-1 730 0.89%
SUSPECT & DA 755 0.92%

33
 Table 2 - Investment behavior of
SUSPECT firms
• investment for years t-3 thru t+3
• Investment relative to control groups of
firms ranked by size and industry
• Results for total investment and its
components, capital expenditures, and
non-capital expenditures

34
 Table 2, cont’d

• column 1: total investment

• SUSPECT firms with overinvest during the period of upward
management, and then subsequently underinvest
• Year 0: SUSPECT firms invest 1.9% more than comparable
firms, as a % of TA
• year +1: invest 2.8% less
• relative investment decline of 4.7% (of TA)
• Columns 2, 3, and 4 (CAPEXP, non-CAPEXP, Employment)
• Consistent with Kedia and Philippon and McNichols and
Stubben
35
 Table 2:
Investments Activities partitioned by Alternative Earnings Management Strategies throughout
Time among SUSPECT Firms

Year SUSPECT FIRMS

INVEST CAPEX NONCAPEX GROW EMPL

-3 0.001 0.002 0.001 0.002 0.001

-2 0.002 0.004 0.002 0.003 0.002

-1 0.014 0.022 0.019 0.017 0.006

0 0.019 0.026 0.029 0.013 0.005

1 -0.028 -0.032 -0.026 -0.024 -0.001

2 -0.012 -0.011 -0.009 -0.007 -0.002

3 -0.004 -0.003 -0.002 -0.003 0.002

36
 Table 3 - Investment behavior
for different EM strategies
• investment for years t-3 thru t+3
• Investment relative to control groups of
firms ranked by size and industry
• Results for total investment and its
components, capital expenditures, and
non-capital expenditures

37
 Table 3, cont’d
• All strategies: overinvestment in the period
up to and including EM year; subsequent
underinvestment
• Panel A – high DA firms overinvest during
the period upto and including the EM year,
and then subsequently underinvest
• Panels B – D: same for real EM firms
• real EM firms have even greater over-
and underinvestment than high DA
38
firms
 Table 3:
Investment Activities for Different EM strategies
Year Panel A - Extreme decile of DA Panel B - INCR_SALES&DECR_CFO

INVEST CAPEX NONCAPEX GROW EMPL INVEST CAPEX NONCAPEX GROW EMPL

-3 0.002 0.003 0.002 0.002 0.001 0.001 0.001 0.002 0.002 0.001

-2 0.002 0.002 0.001 0.001 0.002 0.001 0.002 0.001 0.003 0.002

-1 0.013 0.006 0.005 0.010 0.003 0.015 0.011 0.005 0.009 0.003

0 0.015 0.012 0.013 0.012 0.005 0.029 0.023 0.018 0.017 0.005

1 -0.021 -0.023 -0.019 -0.018 -0.001 -0.013 -0.017 -0.009 -0.026 -0.004

2 -0.016 -0.015 -0.014 -0.008 -0.004 -0.008 -0.004 -0.001 -0.008 0.003

3 -0.003 -0.004 -0.003 0.002 0.001 0.001 0.002 0.003 -0.002 0.001

Year Panel C - DISX_CUT Panel D - COGS_CUT&∆INV>0

INVEST CAPEX NONCAPEX GROW EMPL INVEST CAPEX NONCAPEX GROW EMPL

-3 0.001 0.002 0.001 0.002 0.002 0.003 0.002 0.001 0.003 0.001

-2 0.002 0.003 0.002 0.001 0.003 0.011 0.003 0.002 0.005 0.002

-1 0.017 0.008 0.003 0.004 0.006 0.029 0.017 0.003 0.012 0.004

0 0.024 0.018 0.017 0.011 0.009 0.037 0.035 0.027 0.019 0.003

1 -0.029 -0.021 -0.023 -0.014 -0.003 -0.046 -0.041 -0.029 -0.026 -0.002

2 -0.012 -0.016 -0.013 -0.007 -0.002 -0.014 -0.016 -0.017 -0.011 -0.003
39
3 -0.008 -0.002 -0.003 0.002 0.001 -0.007 -0.002 -0.002 -0.005 0.002
Table 4 - Control for investment
opportunities
• investment is a function of investment
opportunities and liquidity
• Omitted factors may be correlated with
measures of earnings management
• relation between investment and EM may
be due to omitted factors
• i.e., excess investment might really be
optimal given the firm’s opportunity set
40
 Investment as a function of
fundamentals and earnings
management
• Insert equation (10) here
• Model based on Biddle, Hilary, and Verdi
(2008)
• Augmented by SUSPECT, EM, and
SUSPECT*EM

41
 Investment model
• dependent variable: INVEST, CAPEX, or NONCAPEX,
scaled by total assets (TA)
• LOG_ASSET is the log of total assets
• MKT_BK is MV of equity/BV of TA
• LEVERAGE is long term debt/MV of equity
• SLACK is cash/PPE
• AGE is current year - first year on CRSP
• OP_CYCLE is ln(AR/sales+inv/CGS)* 360
• LOSS = 1 if NI before extra.items is negative and zero
otherwise;
• TANGIBLE is PPE/TA
• DIVIDEND = 1 if the firm paid dividends and zero otherwise.
42
 Table 4, Panel A
Results of equation (10)
• Overall, the coefficients on the
fundamentals are consistent with
expectations, and equation (10) explains
about 25% of the cross-firm variation in
investment.

43
 Focus on SUSPECT*EM
• focus on firms most likely to have
managed earnings, but by different means
• coefficients on SUSPECT*EM capture the
overinvestment for suspect firms
differentiated by strategy
• enable us to compare the effects of
different earnings management strategies
on excess investment.

44
 Results for SUSPECT*EM
• Table 4, Panel A
• coefficients on all of the interaction terms
are significantly positive
• shows that firms managing earnings by
any of the strategies overinvest
• the coefficients on the real earnings
management interactions are two to four
times as great as the coefficient on the
accrual interaction
45
 Table 4, Panel A, cont’d
• Firms increasing production to cut COGS
have the greatest overinvestment: 14.2%
of TA
• followed by firms cutting discretionary
expenditures: 8.1%
• High DA firms - overinvestment of 3.1%

46
 Table 4:
Relation between Investments and Alternative Earnings Management Strategies
Panel A: Dependent variable is INVEST
EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.083 0.082 0.078 0.085
(1.39) (1.69) (3.15) (3.71)
MKT-BK 2.408 2.506 2.574 2.498
(11.17) (12.08) (13.57) (14.23)
LEVERAGE -5.638 -5.572 -5.664 -5.617
(-13.07) (-12.35) (-8.17) (-9.61)
SLACK -0.053 -0.049 -0.052 -0.058
(-0.69) (-0.63) (-1.09) (-0.92)
AGE -0.071 -0.074 -0.069 -0.071
(-8.26) (-7.05) (-5.67) (-7.12)
OP_CYCLE -0.867 -0.853 -0.842 -0.857
(-3.51) (-3.61) (-4.99) (-2.95)
LOSS -3.613 -3.704 -3.657 -3.639
(-12.18) (-11.94) (-8.64) (-7.63)
TANGIBLE 11.183 11.374 11.327 11.403
(12.79) (14.06) (9.84) (9.23)
DIVIDEND -0.431 -0.442 -0.433 -0.439
(-3.26) (-3.26) (-3.57) (-3.83)
SUSPECT 0.065 0.062 0.064 0.064
(3.72) (4.01) (3.72) (3.54)
EM 0.019 0.025 0.038 0.027
(4.05) (4.16) (5.06) (4.38)
SUSPECT*EM 0.031 0.081 0.142 0.063
(2.71) (3.04) (3.37) (4.12)
Adj. R2 0.263 0.243 0.284 0.253 47
 Table 4, Panels B and C
• Results due mainly to CAPEXP (Panel B)
• Little variation in NONCAPEXP (Panel C)

48
 Panel B: Dependent variable is CAPEX

EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.091 0.093 0.088 0.096
(2.15) (2.14) (2.96) (3.26)
MKT-BK 2.854 2.813 2.896 2.746
(8.16) (7.34) (10.67) (9.34)
LEVERAGE -4.643 -4.439 -4.536 -4.494
(-10.27) (-10.16) (-8.61) (-8.75)
SLACK -0.033 -0.035 -0.031 -0.036
(-0.57) (-0.72) (-0.67) (-0.79)
AGE -0.061 -0.059 -0.064 -0.055
(-5.78) (-6.02) (-4.98) (-5.36)
OP_CYCLE -0.741 -0.709 -0.712 -0.723
(-4.78) (-3.94) (-4.11) (-3.16)
LOSS -3.126 -3.137 -2.998 -3.113
(-10.81) (-10.68) (-9.36) (-9.49)
TANGIBLE 10.718 10.824 10.735 10.647
(11.76) (12.67) (10.32) (11.46)
DIVIDEND -0.327 -0.329 -0.332 -0.431
(-3.57) (-3.56) (-3.69) (-3.98)
SUSPECT 0.046 0.045 0.047 0.043
(3.23) (3.51) (3.96) (4.18)
EM 0.014 0.019 0.036 0.025
(2.84) (2.98) (4.67) (3.81)
SUSPECT*EM 0.024 0.074 0.086 0.051
(2.98) (3.26) (2.83) (3.45)
Adj. R2 0.271 0.273 0.314 0.288

49
 Panel C: Dependent variable is NONCAPEX

EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.026 0.024 0.018 0.021
(1.32) (0.94) (2.73) (-3.34)
MKT-BK 1.554 1.539 1.631 1.627
(4.43) (3.69) (4.58) (3.92)
LEVERAGE -2.402 -2.417 -2.411 -2.334
(-3.76) (-4.10) (-4.56) (-3.89)
SLACK -0.015 -0.013 -0.012 -0.011
(-0.61) (-0.13) (-0.22) (-0.43)
AGE -0.066 -0.067 -0.064 -0.063
(-5.23) (-5.16) (-4.36) (-4.68)
OP_CYCLE 0.616 0.591 0.584 0.603
(3.16) (3.29) (4.32) (3.28)
LOSS -2.478 -2.467 -2.513 -2.498
(-7.84) (-9.39) (-8.94) (-7.82)
TANGIBLE -9.286 -9.258 -9.239 -9.351
(-7.14) (-6.34) (-7.03) (-6.81)
DIVIDEND -0.215 -0.218 -0.212 -0.214
(-2.69) (-2.71) (-3.07) (-2.67)
SUSPECT 0.008 0.011 0.009 0.013
(2.27) (1.42) (1.27) (1.46)
EM 0.014 0.018 0.024 0.015
(2.39) (1.83) (2.14) (2.03)
SUSPECT*EM 0.008 0.004 0.006 0.007
(1.48) (0.83) (1.09) (1.89)
Adj. R2 0.248 0.217 0.221 0.259

50
 Table 4, Panel D
• Difference between coefficients on DA vs
real earnings management proxies are
highly statistically significant
• Summary: firms engaging in real earnings
management overinvest more than firms
engaging in accrual earnings management

51
Panel D: Investments (INVEST) and Different Earnings Management Strategies

EM = EM = EM =
&DISX_CUT CUTS&∆INV>0 INCR_SALES&
DECR_CFO

SUSPECT 0.064 0.063 0.064

(3.81) (3.86) (3.79)
DA 0.018 0.017 0.019
(4.27) (4.12) (4.22)
EM 0.026 0.039 0.028
(4.59) (5.27) (4.52)
SUSPECT*DA 0.030 0.029 0.028
(2.86) (3.01) (3.16)
SUSPECT*EM 0.083 0.146 0.067
(3.72) (3.64) (4.96)

F-Tests for DA = EM and SUSPECT*DA = SUSPECT*EM

DA = EM
12.37 13.21 11.98
SUSPECT*DA =
16.92 27.48 17.35
SUSPECT*EM

52
 Intertemporal relation between
EM and investment
• shows whether earnings management
precedes the excess investment
• McNichols and Stubben: if earnings
management causes overinvestment, then
the overinvestment should be related to
current and past earnings management
• estimate investment model (eq’n (10)),
augmented with measures of firms’
earnings management from t-2 thru t+1
53
• do not include SUSPECT, which only
 Table 5
• current investments significantly related to
both accrual-based and real current, past,
and future earnings management
• coefficients on EMt, EMt-1, and EMt+1 > 0
• relationship between investments and
earnings management activities is the
strongest in the concurrent year

54
 Table 5, cont’d
• relation between investments and EM in
year t+1 is consistent with some portion of
earnings management to offset poor
returns from over investments made in
past periods.
• effects of real EM on investment are
greater than the effects of accrual EM
earnings management
• additional evidence that firms that engage
in real EM experience greater 55
 Table 5:
Investments and Earnings Management Strategies over Time

Panel A: Dependent variable is INVEST

EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.083 0.078 0.071 0.079
(2.45) (1.74) (3.29) (3.12)
MKT-BK 2.473 2.541 2.532 2.487
(9.12) (12.25) (13.07) (13.41)
LEVERAGE -5.401 -5.613 -5.598 -5.628
(-10.24) (-11.69) (-8.39) (-9.17)
SLACK -0.057 -0.0451 -0.049 -0.053
(-0.83) (-0.68) (-1.02) (-0.81)
AGE -0.076 -0.077 -0.068 -0.073
(-5.29) (-6.08) (-5.41) (-7.38)
OP_CYCLE -0.857 -0.862 -0.859 -0.848
(-3.41) (-3.43) (-4.84) (-2.83)
LOSS -3.504 -3.721 -3.662 -3.645
(-9.79) (-10.38) (-8.73) (-7.86)
TANGIBLE 11.591 11.238 11.289 11.368
(11.34) (12.34) (9.17) (9.46)
DIVIDEND -0.429 -0.448 -0.441 -0.447
(-3.68) (-3.81) (-3.12) (-3.46)
EM t-2 0.005 0.004 0.005 0.003
(0.96) (0.68) (0.84) (0.57)
EM t-1 0.009 0.011 0.019 0.014
(1.56) (1.74) (1.87) (2.01)
EM t 0.018 0.025 0.038 0.027
(4.33) (4.16) (5.06) (4.38)
EMt+1 0.009 0.013 0.016 0.014
(2.23) (2.19) (2.31) (1.98) 56
Adj. R2 0.262 0.258 0.296 0.272
 Table 5:
Investments and Earnings Management Strategies over Time

Panel B: Dependent variable is CAPEX

EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.094 0.095 0.091 0.093
(2.58) (2.37) (2.84) (3.01)
MKT-BK 2.772 2.834 2.858 2.863
(8.28) (7.12) (10.29) (9.67)
LEVERAGE -4.541 -4.583 -4.561 -4.486
(-8.79) (-10.35) (-8.14) (-8.28)
SLACK -0.037 -0.034 -0.032 -0.034
(-0.93) (-0.65) (-0.62) (-0.83)
AGE -0.059 -0.054 -0.058 -0.056
(-4.52) (-6.36) (-4.46) (-5.09)
OP_CYCLE -0.719 -0.721 -0.719 -0.728
(-4.16) (-3.34) (-4.38) (-3.21)
LOSS -3.138 -3.156 -3.104 -3.116
(-9.89) (-10.39) (-10.67) (-9.63)
TANGIBLE 10.674 10.786 10.763 10.656
(11.78) (11.37) (10.41) (11.14)
DIVIDEND -0.34 -0.326 -0.334 -0.329
(-3.12) (-3.42) (-3.76) (-3.37)
EM t-2 0.004 0.005 0.004 0.004
(0.68) (0.72) (0.42) (0.72)
EMt-1 0.011 0.012 0.018 0.015
(2.89) (1.86) (1.93) (2.24)
EM t 0.015 0.019 0.036 0.025
(4.39) (2.98) (4.67) (3.81)
EM t+1 0.008 0.012 0.013 0.012
(2.79) (2.58) (2.26) (1.88)
Adj. R2 0.278 0.291 0.334 0.316
57
 Table 5:
Investments and Earnings Management Strategies over Time

Panel C: Dependent variable is NONCAPEX

EM = DA EM = EM = EM =
DISX_CUT COGS_CUT INCR_SALES
&DECR_CFO
&∆INV>0
LOG_ASSET 0.026 0.026 0.022 0.027
(2.75) (0.83) (2.36) (3.17)
MKT-BK 1.606 1.536 1.643 1.629
(4.81) (3.42) (4.15) (3.74)
LEVERAGE -2.452 -2.412 -2.414 -2.329
(-4.61) (-4.16) (-4.61) (-3.41)
SLACK -0.013 -0.012 -0.011 -0.013
(-0.63) (-0.19) (-0.26) (-0.38)
AGE -0.064 -0.061 -0.063 -0.065
(-4.38) (-5.25 (-4.32) (-4.16)
OP_CYCLE 0.614 0.587 0.586 0.611
(3.97) (3.42) (4.63) (3.47)
LOSS -2.497 -2.456 -2.521 -2.493
(-7.56) (-8.61) (-8.14) (-7.54)
TANGIBLE -9.2401 -9.267 -9.243 -9.357
(-6.42) (-6.63) (-7.11) (-6.43)
DIVIDEND -0.209 -0.215 -0.216 -0.218
(-3.44) (-2.74) (-3.23) (-2.76)
EM t-2 0.003 0.004 0.003 0.002
(0.61) (0.51) (0.21) (0.43)
EM t-1 0.007 0.008 0.011 0.008
(1.64) (1.26) (1.78) (1.53)
EM t 0.009 0.018 0.024 0.015
(1.39) (1.83) (2.14) (2.03)
EMt+1 0.004 0.008 0.012 0.008
(1.59) (1.42) (1.98) (1.57)
Adj. R2 0.253 0.223 0.246 0.277 58
 Intertemporal evidence-
summary
• evidence implies that EM leads or occurs
contemporaneously with over investments
• smaller statistical significant association
between investments and EM activities in
the subsequent year is consistent with
some portion of earnings management to
offset poor returns from over investments
made in past periods.

59
 summary
• first paper to examine the economic effects of
real EM
• real EM firms overinvest and subsequently
underinvest in the years surrounding the
earnings management.
• excess investment associated with real EM is
greater than excess investment associated with
DA

60