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Open Access Publications from the University of California

The Use of Discretionary Expenditures as an Earnings Management Tool: Evidence from Financial Misstatement Firms

  • Author(s): Sun, Yuan
  • Advisor(s): Dechow, Patricia
  • et al.

This study examines the use of real earnings management in a setting where earnings manipulation is likely to have occurred. Using firms subject to SEC Accounting and Auditing Enforcement Releases, I find that misstating firms show lower discretionary SG&A but higher discretionary R&D than the control sample in the years in which they overstate earnings. I then investigate whether this result is explained by heightened management incentives to support stock prices. I find evidence consistent with investors overvaluing high discretionary R&D and low discretionary SG&A during misstatement years. Overall, these results suggest that while cutting SG&A is considered a feasible earnings management tool to inflate earnings and stock prices, cutting R&D is not a viable option in a setting where managers desire to signal growth and maintain high stock market valuations.

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