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Real earnings manipulation and future performance: A revisit using quarterly data of firms with debt covenants

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  • Weiwei Wang
  • Kenneth Zheng

Abstract

We investigate the implications of real earnings manipulation (REM) and reversals of REM on firms’ future operating performance using quarterly data of firms with debt covenants. In the presence of debt covenants, firms are under persistent pressure to deliver financial results that exceed the thresholds of the debt covenant requirements. We find that REM is associated with lower future operating performance. More importantly, the reversals of REM in the following quarter have an incremental positive effect on future performance, which largely offsets the negative effect of REM. These results provide new evidence on REM reversals that differs from the existing literature. Instead of interpreting the reversals as an indication of true REM based on their negative association with future performance documented in Vorst (2016), our results suggest that REM reversals may be indicative of firms rewinding REM subsequently, which reduces the REM damage to firms’ future operations.

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  • Weiwei Wang & Kenneth Zheng, 2020. "Real earnings manipulation and future performance: A revisit using quarterly data of firms with debt covenants," Review of Financial Economics, John Wiley & Sons, vol. 38(1), pages 76-96, January.
    • Handle: RePEc:wly:revfec:v:38:y:2020:i:1:p:76-96
    DOI: 10.1002/rfe.1070
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    2. Manish Kumar & Madhu Vij & Rishabh Goswami, 2021. "Effect of Real Earnings Management on Firm Performance: Evidence from India," Vision, , vol. 27(3), pages 386-396, June.
    3. Manu Abraham, 2024. "Shariah compliance and earnings management in India: Insights on reporting transparency and financial stability," Modern Finance, Modern Finance Institute, vol. 2(1), pages 145-165.

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