Changes in earnings quality over the last three decades: evidence from rounding of Street and GAAP earnings numbers

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School of Business | Master's thesis
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This study examines the changes in earnings quality over the last three decades, measured by a rounding-up behavior of earnings figures. Previous studies have stated that the distribution of digits in earnings numbers deviate from Benford’s law, which determines the probability of each digit to appear as the first, the second, the third or the fourth significant digit in different numbers. A deviation from Benford’s law often refers to a manipulation of earnings figures, which means rounding up of the second significant digit, in order to increase the first significant digit by one. This behavior results in a situation where there appear more zeros and less nines than expected in the second significant digit of an earnings number. The changes in earnings quality have been investigated over a time period from 1986 to 2014. The study has been conducted by using a sample of U.S. companies, focusing on two different earnings per share (EPS) figures. The first EPS figure is based on the generally accepted accounting principles (GAAP EPS), whereas the other EPS figure (Street EPS) is often excluding extraordinary items. The results indicate that the quality of earnings has improved over the sample period. In the late 1980s and during the 1990s, the rounding-up behavior has been striking, which appears as significant deviations from Benford’s law. In the early 2000s, the rounding-up behavior has reduced significantly, and the declining trend turns out to continue until the end of the sample period. The results also show that the deviations from Benford’s law are higher in Street EPS numbers, which indicates that Street EPS figures are manipulated to a larger extent.
Thesis advisor
Jarva, Henry
earnings quality, earnings management, rounding-up behaviour, Benford's law, Street earnings
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