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Firm Performance and Earnings Management Around Dividend Change Announcements

Using a sample of dividend-paying firms, we show that much of the variation in accruals and real activities can be explained by firms' different performance trajectories. High (low) performance firms spend more (less) on SG&A and CAPEX and hold what appear to be abnormally low (high) levels of accruals, which is appropriate value-maximizing behavior given their superior (inferior) growth and profitability trajectories. Additionally, we find that standard measures of real activities earnings management have a stronger relation with changes in dividends than unexpected changes in firms' earnings; firms that appear to manage earnings to a greater extent change their dividends by larger amounts; and standard earnings management metrics are unimportant in explaining changes in firm value around dividend change announcements. These results are consistent with the notion that applying standard earnings management metrics without taking performance into account can result in researchers mistaking managers' efforts to increase firm value by reporting smoother streams of earnings and dividends over time with evidence of earnings manipulation.