Evidence that financing decisions contribute to the zero-earnings discontinuity

Naser Makarem (), Frank Hong Liu () and Lei Chen ()
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Naser Makarem: University of Aberdeen
Frank Hong Liu: Loughborough University
Lei Chen: Loughborough University

Review of Quantitative Finance and Accounting, 2023, vol. 60, issue 1, No 7, 257 pages

Abstract: Abstract In this paper we argue that financing decisions contribute to the zero-earnings discontinuity. We find a discontinuity in the distribution of earnings before tax and earnings before special items, but not in the distribution of earnings before interest which suggests that interest expense contributes to the zero-earnings discontinuity. To investigate the role of interest expense in the zero-earnings discontinuity, we further show that there was a discontinuity in the distribution of the level of debt issues around zero earnings contemporaneous with the zero-earnings discontinuity. We also show that the recent disappearance of zero-earnings discontinuity is coincident with the disappearance of the discontinuity in the debt issuance distribution. Overall, our findings suggest that the level of debt contributed to the zero-earnings discontinuity when it existed.

Keywords: Earnings distribution; Earnings discontinuity; Earnings management; Financing decisions; Debt issuance (search for similar items in EconPapers)
JEL-codes: M41 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11156-022-01091-7

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