The Extent of Earnings Management in the U.S. and Germany

Abstract

This paper compares the extent to which U.S. and German companies manage their earnings in order to exceed earnings thresholds. Following Burgstahler and Dichev (1997), we analyze the distribution of earnings to discover whether U.S. and German firms have managed reported earnings in order to avoid losses, decreases in earnings, or earnings below the forecasts of analysts. The data for our tests have been taken from the Worldscope and the Osiris databases. The sample comprises 38,714 firm-year observations for U.S. companies and 3,524 firm-year observations for German companies for the years 1991 to 2000. Given the pronounced differences between the institutional environments of U.S. and German firms, we expect the extent of thresholdoriented earnings management to differ between the two countries. However, differences between the extent of earnings management to avoid losses and earnings decreases in the U.S. and in Germany are not statistically significant. By contrast, earnings management in order to avoid negative earnings surprises appears to be more prevalent in the U.S. than in Germany. This study also contributes to the literature by making methodological advances. We introduce a measure of the asymmetry of distributions around thresholds, which allows us to make statistically meaningful comparisons across different distributions. Furthermore, we demonstrate that the measurement of earnings management is sensitive to the choice of the interval width. Additionally, we show that firms' propensity to manage earnings depends on firm characteristics such as size, leverage, and growth.