Does the end justify the means? Just beating the analysts’ consensus, earnings management, and CDS markets

• In Event: Debt Contracting II

Abstract

We deploy credit default swaps (CDS) data to assess the perceived value of just beating the analysts’ consensus forecast (JBE) through non-operating means. In particular, we examine a measure inspired by Duffie and Lando (2001) and quoted CDS spreads at short and long maturities to assess the value of ad hoc JBE, as well as whether the effect pertain to measurement (discount rate effect) or expected cash flows (cash flow effect) through the lens of credit markets. The findings support that JBE is generally treated as “non-event” by CDS markets, but the investors perceive non-operating approaches to achieving the target as damaging both in the discount rate and cash flow sense. As a part of the analysis, we also validate the measure based on the Duffie and Lando (2001), documenting a significantly positive association between CDS slope and the propensity to experience a subsequent Accounting and Audit Enforcement Release or accounting-related restatement. The study contributes to a spectrum of literatures, providing novel evidence on the implications of earnings management to meet financial reporting targets. More generally, we believe that the methodology we propose applies to a variety of settings, offering means to sharpen inferences on the role of measurement vs. investment quality.

Authors

• Aytekin Ertan, London Business School

• Kalin S. Kolev, Yale University

• Stephen Adam Karolyi, Carnegie Mellon University