Earnings management and the distribution of earnings relative to targets: UK evidence
In this paper we provide the first international evidence on discontinuities in the distribution of reported earnings, using a large sample of UK firms. We examine the discontinuity phenomenon in the context of earnings management. We report that the empirical distributions of earnings before discretionary working capital accruals does not reflect the unusually high frequencies of small surpluses and unusually low frequencies of small deficits relative to targets found in the distribution of actual (reported) earnings, i.e. after discretionary working capital accruals. We find that discretionary working capital accruals have the effect of significantly increasing the frequencies of firms achieving earnings targets both overall and by small margins. Thus, we document an explicit link between working capital accruals-based earnings management and the discontinuities observed in the empirical distribution of earnings relative to targets.