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To What Extent Does the Financial Reporting Process Curb Earnings Surprise Games?

Lawrence D. Brown and Arianna Spina Pinello
Journal of Accounting Research
Vol. 45, No. 5 (Dec., 2007), pp. 947-981
Stable URL: http://www.jstor.org/stable/4622062
Page Count: 35
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Since scans are not currently available to screen readers, please contact JSTOR User Support for access. We'll provide a PDF copy for your screen reader.
To What Extent Does the Financial Reporting Process Curb Earnings Surprise Games?
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Abstract

Managers play earnings surprise games to avoid negative earnings surprises by managing earnings upward or by managing analysts' earnings expectations downward. We investigate the effectiveness of the financial reporting process at restraining earnings surprise games. Because the annual reporting process is subject to an independent audit and more rigorous expense recognition rules than interim reporting, it provides managers with fewer opportunities to manage earnings upward. We document that, relative to interim reporting, annual reporting reduces the likelihood of income-increasing earnings management and, to a lesser extent, of negative surprise avoidance, but increases the magnitude of downward expectations management. Our findings suggest that regulatory attempts to monitor corporations' internal checks and balances are likely to be more effective at curbing upward earnings management than at mitigating negative surprise avoidance.

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