Does a Disaggregated Earnings Forecast Enable Detection of Management’s Manipulation of Real Activities?
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This study proposes that disaggregated earnings forecasts would potentially help investors to detect managers’ manipulation of real activities. A disaggregated forecast allows an item-by-item comparison of actual earnings against the forecasted numbers. It thus enables investors to identify changes in individual cost items that have contributed to the discrepancy between the forecasted and reported earnings. This study posits that the changes in cost items that are perceived to be controllable by management would lead investors to make inferences about management’s dispositions. Conversely, the changes that are perceived to be uncontrollable by management would unlikely be attributed to management. Based on attribution theory, the study hypothesizes that when a disaggregated earnings forecast is available, investors’ reactions to a reported earnings surprise would be a joint function of the earnings surprise and investors’ perception of management’s discretion over the cost item responsible for the earnings surprise. In specific, when firms beat the forecasted earnings, investors are expected to react less positively if the performance is accompanied by a reduction in discretionary expenses than if it is accompanied by a reduction in nondiscretionary expenses. In contrast, when firms miss forecasted earnings, investors are predicted to react less negatively if the performance is accompanied by an increase in discretionary expenses than if it is accompanied by an increase in nondiscretionary expenses. This study further proposes an experimental design to test this hypothesis. This study contributes the current literature by setting the stage for future studies to test disaggregated forecasts as a mechanism to detect management’s manipulation of real activities.
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