Potential Errors in Detection of Earnings Management : Reexamining Studies Investigating the Amt of 1986

We seek to document errors that could affect studies of earnings management. The case of earnings management in response to the book income adjustment (BIA) of the alternative minimum tax (AMT) offers a unique laboratory because the incentives to manage book income downward in 1987 appear so strong that there was little doubt that earnings would be managed by affected firms. We hypothesize that subtle methodological biases are more likely in this setting. Five earlier papers studying this issue using different methodologies and samples all conclude that earnings were reduced. A reexamination of these studies uncovers potential biases related to a variety of factors, including scaling variables, the selection of affected and control samples, and measurement error in estimated discretionary accruals. And a reexamination of the argument underlying these studies suggests that the incentives to manage earnings are less powerful than initially predicted, and are partially mitigated by tax and non-tax factors. As a result, we believe that the extent of earnings management that occurred in 1987 in response to the BIA remains an unresolved issue.Key Words: Earnings management, Methodological biases, Book income adjustment, Alternative minimum tax, AMT