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Earnings Quality: Evidence from the Field - Rotman School of ...

Earnings Quality: Evidence from the Field - Rotman School of ...

Earnings Quality: Evidence from the Field - Rotman School of

Abstract: Earnings Quality: Evidence from the Field Ilia Dichev Goizueta Business School, Emory University John Graham Campbell R. Harvey Fuqua School of Business, Duke University National Bureau of Economic Research Shiva Rajgopal Goizueta Business School, Emory University Comments welcome September 9, 2012 We provide new insights into earnings quality from a survey of 169 CFOs of public companies and indepth interviews of 12 CFOs and two standard setters. Our key findings include (i) high-quality earnings are sustainable and are backed by actual cash flows; they also reflect consistent reporting choices over time and avoid long-term estimates; (ii) about 50% of earnings quality is driven by non-discretionary factors; (iii) about 20% of firms manage earnings to misrepresent economic performance, and for such firms 10% of EPS is typically managed; (iv) CFOs believe that earnings manipulation is hard to unravel from the outside but suggest a number of red flags to identify managed earnings; and (v) CFOs disagree with the direction the FASB is headed on a number of issues including the sheer number of promulgated rules, the top-down approach to rule-making, the de-emphasis of the matching principle, and the overemphasis of fair value accounting. CFOs lament that a rules-based culture makes the audit function centralized and mechanical, and stunts the development of audit professionals. We acknowledge excellent research assistance by Mengyao Cheng, Jivas Chakravarthy and Stephen Deason. We appreciate written comments on an earlier version of the paper from Vic Anand, Sudipta Basu, Mark Nelson, Paul Healy, Urton Anderson and especially Pat O’Brien, Terry Shevlin, Michelle Hanlon, and Jerry Zimmerman. We thank workshop participants at Texas A&M University, Cornell University, Harvard Business School, Wharton, University of Technology – Sydney, University of Melbourne, Virginia Commonwealth University, Stanford Summer Camp, Temple University, Ohio State University, Indian School of Business, Minnesota Financial Accounting Conference and the 2012 AAA Doctoral Consortium. We acknowledge helpful comments on a preliminary version of the survey instrument from workshop participants at Emory University and from Bob Bowen, Dave Burgstahler, Brian Bushee, Dan Collins, John Core, Patty Dechow, Mark DeFond, Jennifer Francis, Weili Ge, Jeff Hales, Michelle Hanlon, Gary Hecht, Kathryn Kadous, Mark Lang, Russ Lundholm, Mark Nelson, Stephen Penman, Kathy Petroni, Grace Pownall, Cathy Schrand, Terry Shevlin, Shyam Sunder, Terry Warfield, Ross Watts, Greg Waymire, Joe Weber and Jerry Zimmerman, and two anonymous standard-setters. We thank Dean Larry Benveniste and Trevor Harris for arranging interviews. We are grateful for CFO magazine’s help in this project, though the views expressed here do not necessarily reflect those of CFO. Finally, we thank David Walonick and Statpac, Inc. for timely and dedicated work in coding and delivering the survey.

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