Research Discussion Papers, Bank of Finland
Bill B. Francis
Abnormal real operations, real earnings management, and subsequent crashes in stock prices
(), Iftekhar Hasan
() and Lingxiang Li
Abstract: We study the impact of firms’ abnormal business operations
on their future crash risk in stock prices. Computed based on real earnings
management (REM) models, firms' deviation in real operations from industry
norms (DRO) is shown to be positively associated with their future crash
risk. This association is incremental to that between discretionary
accruals (DA) and crash risk found by prior studies. Moreover, after
Sarbanes-Oxley Act (SOX) of 2002, DRO's predictive power for crash risk
strengthens substantially, while DA's predictive power essentially
dissipates. These results are consistent with the prior finding that
managers shift from accrual earnings management (AEM) to REM after SOX. We
further develop a suspect-firm approach to capture firms' use of DRO for
REM purposes. This analysis shows that REM-firms experience a significant
increase in crash risk in the following year. These findings suggest that
the impact of DRO on crash risk is at least partially through REM.
Keywords: crash risk; deviation in real operations; earnings management; real earnings management; Sarbanes-Oxley; (follow links to similar papers)
JEL-Codes: D89; G19; M10; M41; (follow links to similar papers)
54 pages, July 9, 2014
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- This paper is forthcoming as:
Francis, Bill B., Iftekhar Hasan and Lingxiang Li, 'Abnormal real operations, real earnings management, and subsequent crashes in stock prices', Review of Quantitative Finance and Accounting.
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