Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management - trade-off and substitution evidence

Aug 31, 2026

Managers use two earnings management tools—real activities manipulation and accrual-based earnings management—and this study examines whether they function as substitutes. The analysis documents how firms trade off the two approaches according to their relative costs, and how the level of accrual-based earnings management adjusts to the degree of realized real activities manipulation. An empirical model incorporating both methods’ costs and managers’ sequential decisions yields large-sample evidence consistent with substitution between the strategies.

LanguageEnglish

CategoryResearch & Report

FormatPDF

Pages29

Reading Time1 h 13 min

AccessFree to download

I. Introduction

Trade-off between the two earnings management strategies

Definitions and mechanisms

Importance of studying substitution and costs

THE ACCOUNTING REVIEW American Accounting Association Vol. 87, No. 2 DOI: 10 .2308/accr-10196 2012 pp. 675–703 Evidence on the Trade-Off between Real Activities Manipulation and Accrual-Based Earnings Management Amy Y. Zang Hong Kong University of Science and Technology ABSTRACT: I study whether managers use real activities manipulation and accrualbased earnings management as substitutes in managing earnings. I find that managers trade off the two earnings management methods based on their relative costs and that managers adjust the level of accrual-based earnings management according to the level of real activities manipulation realized. Using an empirical model that incorporates the costs associated with the two earnings management methods and captures managers’sequential decisions, I document large-sample evidence consistent with managers using real activities manipulation and accrual-based earnings management as substitutes. Keywords: real activities manipulation; accrual-based earnings management; trade-off. Data Availability: Data are available from public sources indicated in the text. I. INTRODUCTION I study how ﬁrms trade off two earnings management strategies, real activities manipulation and accrual-based earnings management, using a large sample of ﬁrms over 1987–2008 . Prior studies have shown evidence of ﬁrms altering real activities to manage earnings (e.g. , Roychowdhury 2006; Graham et al. 2005) and evidence that ﬁrms make choices between the two earnings management strategies (Cohen et al. 2008; Cohen and Zarowin 2010; Badertscher 2011) . My study extends research on the trade-off between real activities manipulation and accrual-based earnings management by documenting a set of variables that explain the costs of both real and I am grateful for the guidance from my dissertation committee members, Jennifer Francis (chair), Qi Chen, Dhananjay Nanda, Per Olsson, and Han Hong. I am also grateful for the suggestions and guidance received from Steven Kachelmeier (senior editor), Dan Dhaliwal, and two anonymous reviewers. I thank Allen Huang, Moshe Bareket, Yvonne Lu, Shiva Rajgopal, Mohan Venkatachalam, and Jerry Zimmerman for helpful comments. I appreciate the comments from the workshop participants at Duke University, University of Notre Dame, The University of Utah, The University of Arizona, The University of Texas at Dallas, Dartmouth College, University of Oregon, Georgetown University, University of Rochester, Washington University in St. Louis, and Hong Kong University of Science and Technology. I gratefully acknowledge the ﬁnancial support from the Fuqua School of Business at Duke University, the Deloitte Foundation, University of Rochester, and the Hong Kong University of Science and Technology. Errors and omissions are my responsibility. Editor’s note: Accepted by Steven Kachelmeier. Submitted: September 2006 Accepted: July 2011 Published Online: November 2011 676 Zang accrual earnings management. I provide evidence for the trade-off decision as a function of the relative costs of the two activities and show that there is direct substitution between them after the ﬁscal year-end due to their sequential nature. Real activities manipulation is a purposeful action to alter reported earnings in a particular direction, which is achieved by changing the timing or structuring of an operation, investment, or ﬁnancing transaction, and which has suboptimal business consequences. The idea that ﬁrms engage in real activities manipulation is supported by the survey evidence in Graham et al. (2005) .1 They report that 80 percent of surveyed CFOs stated that, in order to deliver earnings, they would decrease research and development (R&D), advertising, and maintenance expenditures, while 55 percent said they would postpone a new project, both of which are real activities manipulation. Unlike real activities manipulation, which alters the execution of a real transaction taki

FAQs

What does the study investigate about earnings management strategies?

It examines whether managers use real activities manipulation and accrual-based earnings management as substitutes when managing earnings.

How do managers decide between real activities manipulation and accrual-based earnings management?

Managers trade off the two methods based on their relative costs, engaging more in the other when one is relatively more costly.

What modeling approach supports the study’s evidence?

The study uses an empirical model that incorporates the costs of both methods and captures managers’ sequential decisions.

Aug 31, 2026

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