Target Size Management: A Long-Run Response to Unpredictable Earnings

• In Event: Earnings Management and Financial Reporting

Abstract

A firm can increase the likelihood it meets EPS thresholds multiple periods in the future by increasing shares today. We hypothesize that managers choose the number of shares to affect this likelihood. We find that firms with unpredictable earnings and firms with managers that are highly sensitive to missing EPS forecasts have more shares outstanding. After an increase in shares, accounting and real earnings management drop in future periods and yet the firm still meets EPS forecasts more frequently. We find no evidence that managers choose shares in response to private information about shortfalls in current period earnings. Our results suggest that studies of earnings management that ignore the impact of shares on the likelihood of meeting forecasts fail to account for an important managerial choice that affects the incentives to manage earnings. Additionally, we provide a new explanation for stock splits, thereby suggesting a link between EPS reporting and capital market activities.

Authors

• Alan D Crane, Rice University

• Chishen Wei, Nanyang Technological University

• Andrew Koch, University of Pittsburgh