• Estimate an “expected” credit rating for a given firm in a given year. • Measure the firms' deviations from their expected ratings.
• Firms below (above) their expected rating manage earnings more upward (downward).
• These firms are successful in achieving future upgrades (downgrades).
This paper examines whether firms that deviate from an empirically modeled (“expected”) credit rating engage in earnings management activities, as measured by abnormal accruals and real activities earnings management. We find evidence that firms use income-increasing (-decreasing) earnings management activities when they are below (above) their expected ratings. We then test whether such actions are successful in helping these firms move toward their expected credit ratings. The results suggest that firms below or above their expected credit ratings may be able to move toward expected ratings through the use of directional earnings management.
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Journal of Accounting & Economics
The Journal of Accounting and Economics is a peer-reviewed academic journal focusing on the fields of accounting and economics.