Real Activities Management and Earnings Expectations: Evidence from Asset Sales

• In Event: Financial Accounting and Reporting 1

Abstract

This paper investigates management’s use of income from asset sales to increase reported earnings toward target. The risk with this type of activity is that management may be sacrificing long term firm value to reach current period expected earnings. We investigate how reported income exclusive of gain (loss) from asset sales, i.e., presale income, relative to three targets (positive EPS, positive growth in EPS, consensus analyst forecast) impacts asset sales, showing that firms which are slightly below earnings targets are more likely to engage in income increasing asset sales, while firms above expectations are more likely to sell income decreasing assets. As an illustration of the impact, 25 percent of firms with presale income below consensus analyst forecasts are able to meet the forecast due to the asset sale.
We then investigate the impact of these strategic asset sales on the industry adjusted future performance of the firm, measured by reported income and future cash flows. Results are inconsistent across benchmarks. Firms selling assets to avoid reporting losses have superior future operating performance, as measured by ROA and cash flows. Firms using asset sale income to meet analysts’ forecasts have superior future operating income, but future cash flows are not significantly improved. However, firms using income from asset sales to achieve growth in earnings have lower future cash flows than those firms which miss expectations.

Authors

• Steven Balsam, Temple University

• Neal Andrew Vanden Berg, Temple University