Firm Performance and Earnings Management Around Dividend Change Announcements

Abstract

Studies that fail to fully consider how performance affects firms' earnings and dividend smoothing activities will identify deviations of discretionary accruals and real activities from sub industry averages as unusual or opportunistic too frequently. We show that much of the variation in accruals and real activities can be explained by firms' different performance trajectories. High (low) petformance dividend-paying firms spend more (less) on SG&A and CAPEX and hold what appear to be abnormally low (high) levels of accruals, which is appropriate value-maximizing behavior given their superior (inferior) growth and profitability trajectories. Additionally, we find that standard measures of real activities-based earnings management have a stronger relation with changes in dividends than unexpected changes in firms' earnings; firms that appear to manage earnings to a greater extent change their dividends by larger amounts; and standard earnings management metrics are unimportant in explaining changes in firm value around dividend change announcements. These results are consistent with the idea that applying standard earnings management metrics to dividend-paying firms without taking performance into account can result in researchers confounding managers' efforts to increase firm value by reporting smoother streams of earnings and dividends over time with evidence of earnings manipulation.