Conditional Conservatism and the Limits to Earnings Management

We examine the impact of conditional conservatism on earnings management. Our findings support the view that conditional conservatism reduces accruals-based earnings management but also triggers a trade-off between accruals and real earnings management. Notwithstanding this trade-off, we show that, overall, more conditionally conservative firms manage earnings less, and as a result, they are less likely to either marginally or habitually beat earnings targets. To corroborate our findings, our identification strategy uses the passage of SFAS 121 as a plausibly exogenous regulatory change that increased the level of conditional conservatism but did not materially affect earnings management. We find that, after the regulation, treated firms reduce accruals-based earnings management and increase real earnings management, and are less likely to be marginal or habitual beaters of earnings benchmarks