Earnings Management during the Financial Crisis

Financial reports and specifically earnings figures are of interest to investors, analysts, and board members since they provide critical information when investment decisions are made (Degeorge et al., 1999). While several figures found in financial statements (e.g. dividends, cash flows, and capital investments) can be used as performance indicators the earnings figure provides significantly more insight into a firm’s performance on the medium to long term. It is therefore not surprising that managers aim to maximize earnings figures through earnings management activities. Earnings management is a tool used by management to meet or exceed expectations in current or future periods. The overall goal being to stabilize earnings of consecutive periods to ensure a low variability. Stable earnings signal less risk, which decreases financing costs and positively impacts the stock price. Considering the importance of earnings it is not surprising that managers aim to meet or exceed earnings targets through specific accounting treatments such as earnings management. The following chapters will focus on accrual earnings management carried out by U.S. non-financial firms during a financial crisis. U.S. firms are chosen over European firms since only the market developments in the U.S. clearly show a negative trend in Gross Domestic Product (GDP) during 2008 and 2009. This makes the distinction of two phases during the financial crisis possible. Usually earnings are managed downward when earnings exceed expectations and upward when predicted levels are not reached. Does this imply that earnings are managed upwards during a financial crisis? This specific question will be answered in this thesis by researching the trend of accrual earnings management during different periods of the financial crisis.