Orphans Deserve Attention : Financial Reporting in the Missing Months When Corporations Change Fiscal Year

We examine firms' financial reporting practices during stub periods that are induced by fiscal year changes and not covered by regular quarters. We find that firms report much lower income for the missing months than for adjacent quarters, mainly by recording higher operating expenses. We also find that managers have various incentives to manage earnings. Executive compensation is not tied to firm performance in the transition period as it is in adjacent fiscal years. Growth firms, firms with poor stock returns, and firms with poor external and internal monitoring tend to manage earnings more. Finally, we find that firms are more likely to meet or beat earnings targets in the subsequent quarter by reporting lower income in the missing months. Investors and analysts perceive the earnings surprise to be less persistent in the quarter after the missing months than in the quarter before