Managers’ financial reporting incentives

David Burgstahler and Elizabeth Chuk

Chapter 3 in Handbook on the Financial Reporting Environment, 2025, pp 35-45 from Edward Elgar Publishing

Abstract: This chapter explores the influence of managers’ beliefs and preferences on subjective judgments required in complex financial reporting decisions. There are frequently incentives to report upward-biased earnings, for example when managers focus on attracting investors, increasing their own compensation, or avoiding debt covenant violations. Conversely, there may instead be incentives to report downward-biased earnings, for example to build “cookie jar reserves” or to “take a big bath.” The chapter outlines three approaches used by academic researchers to document evidence of earnings management: (1) direct estimates from restatements or SEC Accounting and Auditing Enforcement Releases; (2) the association between incentives and proxies for the effects of specific earnings management actions; and (3) discontinuities in earnings distributions around benchmarks. We conclude by emphasizing the importance of understanding these incentives when analyzing financial statements and providing real-life examples of accounting irregularities to illustrate the complexities arising from managerial incentives in financial reporting.

Keywords: Earnings management; Managerial incentives; Accounting discretion; Earnings benchmarks (search for similar items in EconPapers)
Date: 2025
ISBN: 9781800888678
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