Real Earnings Management Leading Up to Dividend Initiation: A Test of Signaling and Agency Theory

• In Event: Financial Accounting and Reporting IV

Abstract

We examine whether CEOs manipulate earnings via discretionary accruals or real earnings management prior to releasing cash reserves back to shareholders. We find that firms create “cookie jar” reserves of cash and earnings in the lucrative, high performance years leading up to dividend initiation. Our results explain the surprisingly stable earnings performance in the period just after dividend initiation. Furthermore, our results show that firms use real as opposed to accrual earnings management, which may help explain the extremely stable earnings quality after dividend initiation measured in previous research. We perform a two stage Heckman model which supports previous research findings that firms substitute real earnings management when net operating assets are available.

Authors

• Deborah Smith, Cleveland State University

• Anita Pennathur, Florida Atlantic University