Horizon-Induced Optimism As A Gateway To Earnings Management

Abstract

Recent work in accounting suggests managerial optimism can lead managers to escalate income-increasing earnings management. In this paper, I examine how a fundamental attribute of the earnings management setting - the amount of time between the earnings management decision and the future reversal - serves as one potential source of managerial optimism. I conduct two experiments to test whether the amount of time between the earnings management decision and the future reversal systematically induces optimism and increases participants' propensity to engage in behavior that is analogous to accruals-based and real earnings management, holding constant incentives, innate optimism, agency frictions, and the information environment. My results indicate that the time between the earnings management decision and the future reversal could increase both forms of earnings management by leading managers to overestimate their ability to compensate for current-period earnings management through strong future performance.