Understanding earnings quality - MIT Sloan School of Management

for the AAER firm executives than for those of control firms. Erickson et al. (2006) and Armstrong
et al. (2009), however, find no evidence of an association between equity-based incentive
compensation and accounting manipulations.
Balsam et al. (2003) find that discretionary accruals are lower prior to option grant dates,
and the effect is stronger in settings in which the grant date is not predictable (Baker et al., 2003).
Coles et al. (2006) examine discretionary accruals in quarters between the date of cancellation and
subsequent reissue of options. Discretionary accruals are relatively income-decreasing leading up to
the reissue. Likewise, McAnally et al. (2008) finds that firms intentionally miss earnings targets
prior to known option grant dates, which reduces stock price (Skinner and Sloan, 2000), but that
firms do not miss earning targets repeatedly in advance of grants.
Insider trading: Beneish (1999) and Summers and Sweeney (1998) find that managers are more
likely to sell their shares and redeem SARs during periods of overstated earnings, where these
periods are identified ex post by AAERs. Beneish (1999) acknowledges that these are cases of
extreme earnings management and that his results might not be generalizable to periods of less
extreme earnings management that nonetheless affects earnings quality. Darrough and Rangan
(2005) find that insider selling is positively related to discretionary current accruals and negatively
related to changes in R&D spending in the year of an IPO. They interpret both results as consistent
with opportunistic earnings management.
5.3.5 Managerial change
Moore (1973), Pourciau (1993), and Geiger and North (2006) find evidence that incoming
managers are more likely to exercise discretion in managing earnings (measured by abnormal
and Shenoy, 2001; Yermack, 1997). A related line of research examines backdating, in which grant dates are
retroactively assigned to historically low share prices (Heron and Lie, 2006, Narayanan et al., 2006).
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