Do Inflation Adjustments Lead to Inflated Earnings? Large Sample Evidence of Managerial Discretion

• In Event: Earnings management

Abstract

We examine the reporting behavior of a comprehensive sample of private firms before and after the elimination in 2007 of an inflation adjustment system in Colombia. We find that firms avoid reporting small losses by exercising considerable discretion in their use of inflation adjustments (IAs). Moreover, we find a significantly greater discretionary use of IAs for firms that rely more on bank financing. Following the removal of IAs in 2007, we further document a significant increase in non-operating earnings for firms just below the zero operating earnings threshold. Our evidence suggests that discontinuities in the distribution of earnings around zero are driven by managerial discretion.

Authors

• Felipe Restrepo, Ivey Business School at Western University

• Jérôme Taillard, Babson College