Abstract
In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 43-67 |
| Number of pages | 25 |
| Journal | Journal of Accounting and Economics |
| Volume | 33 |
| Issue number | 1 |
| DOIs | |
| State | Published - 2002 |
| Externally published | Yes |
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Keywords
- Bonus plans
- Earnings management
- Performance budgets
- Ratchet effect
- Ratchet principle
ASJC Scopus subject areas
- Accounting
- Economics and Econometrics
- Finance
Cite this
Empirical tests of budget ratcheting and its effect on managers' discretionary accrual choices. / Leone, Andrew; Rock, Steve.
In: Journal of Accounting and Economics, Vol. 33, No. 1, 2002, p. 43-67.Research output: Contribution to journal › Article
}
TY - JOUR
T1 - Empirical tests of budget ratcheting and its effect on managers' discretionary accrual choices
AU - Leone, Andrew
AU - Rock, Steve
PY - 2002
Y1 - 2002
N2 - In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis.
AB - In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis.
KW - Bonus plans
KW - Earnings management
KW - Performance budgets
KW - Ratchet effect
KW - Ratchet principle
UR - http://www.scopus.com/inward/record.url?scp=0036183802&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=0036183802&partnerID=8YFLogxK
U2 - 10.1016/S0165-4101(01)00044-1
DO - 10.1016/S0165-4101(01)00044-1
M3 - Article
AN - SCOPUS:0036183802
VL - 33
SP - 43
EP - 67
JO - Journal of Accounting and Economics
JF - Journal of Accounting and Economics
SN - 0165-4101
IS - 1
ER -