Determinants of management's preferences for an earnings threshold

Abstract

Purpose

Previous research has provided mixed evidence on the relative importance of three earnings thresholds that managers seek to achieve: avoiding losses, avoiding earnings declines and avoiding negative earnings surprises. The purpose of this paper is to investigate whether firm‐specific factors influence management's preferences for an earnings threshold.

Design/methodology/approach

Logit models are estimated to explore the relationships between firm‐characteristics and management's perceptions of the relative importance of each threshold.

Findings

This paper finds that: large firms, firms with high growth prospects and firms with high trading volume are more concerned with avoiding negative earnings surprises, while small firms, firms with low growth prospects and firms with low trading volume are more prone to avoid earnings declines and losses; for firms with high analyst forecast accuracy (relative to a random walk model forecast), avoiding negative earnings surprises is more important than avoiding earnings declines and losses; and firms with low analyst forecast dispersion focus more on avoiding negative earnings surprises and losses, while firms with high analyst forecast dispersion focus more on avoiding earnings declines. Overall, this paper shows that firm characteristics do affect management's perceptions of the relative importance of each threshold.

Originality/value

This study recognizes the cross‐sectional differences in the earnings threshold hierarchy. The results suggest that regulators and practitioners should focus on different thresholds for different types of firms when investigating the mechanisms used to achieve the thresholds.

Citation

Fang Li, S. (2010), "Determinants of management's preferences for an earnings threshold", Review of Accounting and Finance, Vol. 9 No. 1, pp. 33-49. https://doi.org/10.1108/14757701011019808