Florida State University Libraries Electronic Theses, Treatises and Dissertations The Graduate School 2019 Meeting-or-Beating Earnings Benchmarks: The Effect of Natural DJonigshaan Psatrkers Follow this and additional works at the DigiNole: FSU's Digital Repository. For more information, please contact [email protected] FLORIDA STATE UNIVERSITY COLLEGE OF BUSINESS MEETING-OR-BEATING EARNINGS BENCHMARKS: THE EFFECT OF NATURAL DISASTERS By JONGHAN PARK A Dissertation submitted to the Department of Accounting in partial fulfillment of the requirements for the degree of Doctor of Philosophy 2019 Jonghan Park defended this dissertation on March 27, 2019. The members of the supervisory committee were: Tianming Zhang Professor Directing Dissertation Yingmei Cheng University Representative Bruce Billings Committee Member Spencer Pierce Committee Member The Graduate School has verified and approved the above-named committee members, and certifies that the dissertation has been approved in accordance with university requirements. ii I dedicate my dissertation to my loving parents, Wonkyu Park and Changsook Yoon and my sister, Soohyun Park. I am truly thankful for their endless love, encouragement and sacrifices. iii ACKNOWLEDGMENTS I would like to express my sincere gratitude to my dissertation chair, Tianming Zhang for his mentorship, guidance, and support. Without his constructive feedback and continuous encouragement, I would not have been able to complete my dissertation. I also would like to thank Bruce Billings, Yingmei Cheng, and Spencer Pierce for their invaluable guidance and service on my dissertation committee. In addition, I would like to thank Kurt Gee for generously allowing me to use the non- GAAP earnings data. I also acknowledge helpful comments from Roby Lehavy, Ted Christensen, Robert hills and workshop participants at Florida State University, 2018 BYU Accounting Research Symposium, the University of New Hampshire, Hong Kong Baptist University, and the Chinese University of Hong Kong (Shenzhen). iv TABLE OF CONTENTS LIST OF TABLES ......................................................................................................................... vi ABSTRACT .................................................................................................................................. vii 1. INTRODUCTION ......................................................................................................................1 2. BACKGROUND AND HYPOTHESIS DEVELOPMENT .......................................................9 3. DATA DESCRIPTION .............................................................................................................16 4. METHODOLOGY ....................................................................................................................17 5. EMPIRICAL TESTS AND RESULTS ....................................................................................21 6. CONCLUSION .........................................................................................................................33 APPENDICES ...............................................................................................................................35 A. VARIABLE DEFINITIONS .....................................................................................................35 B. EXCERPTS FROM 10-K REPORTS .......................................................................................38 C. TABLES ....................................................................................................................................39 REFERENCES ..............................................................................................................................57 BIOGRAPHICAL SKETCH .........................................................................................................62 v LIST OF TABLES 1 SHELDUS Hazard types..........................................................................................................39 2 Descriptive Statistics. ...............................................................................................................40 3 Natural Disaster and Meeting-or-Beating Earnings Benchmarks ............................................43 4 Test of Non-GAAP Exclusions ................................................................................................46 5 Test of Expectation Management ............................................................................................47 6 Test of Market Response to Beaters ........................................................................................48 7 Test of Earnings Management .................................................................................................49 8 Test of Entire Distribution of Earnings Forecasts....................................................................52 9 Natural Disaster and Beating Analyst Forecasts ......................................................................53 10 Test of Using a Sample of Small Firms ...................................................................................54 11 Test of Using Non-GAAP Earnings Disclosed by Managers ..................................................56 vi ABSTRACT I examine whether managers are more likely to meet-or-beat earnings benchmarks when firms experience natural disasters. When a natural disaster strikes and causes significant damages, it could negatively affect a firm’s financial performance, potentially resulting in firms missing earnings targets. In this type of situation, incentives for managers to meet static earnings benchmarks (i.e., zero or last year’s earnings) might weaken because they can shift the blame for poor performance to natural disasters. On the other hand, managers may have stronger incentives to meet dynamic earnings benchmarks (i.e., analyst forecasts) because analysts take into consideration the effect of disasters and missing this benchmark could signal that the effect of disasters was worse than expected. In addition, subjective estimation of losses or charges related to disasters may enable managers to more easily engage in non-GAAP exclusions management to increase the likelihood of meeting analysts’ estimates. Using a comprehensive dataset of natural disasters occurring in the U.S. since 1989, I find that firms affected by natural disasters are more likely to meet-or-beat analyst forecasts through non-GAAP exclusions management. This paper extends the earnings benchmark literature by providing evidence that, when facing unexpected external shocks such as natural disasters, managers could utilize a crisis to make opportunistic accounting choices. vii CHAPTER 1 INTRODUCTION The economic consequences of natural disasters in the United States have increased steadily for several decades, resulting in extensive losses in both tangible assets and human capital. Nevertheless, few studies examine the capital market and financial reporting effects of natural disasters (Cheng et al. 2018). When a natural disaster strikes and inflicts significant damage, it is likely to negatively affect a firm’s operating performance. As a result, affected firms are more likely to miss earnings targets.1 Further, managers may be less incentivized to engage in costly earnings management to achieve earnings benchmarks, as they can easily and credibly shift the blame for the current poor performance to the natural disaster. On the other hand, the economic magnitude of natural disasters is typically difficult for investors or analysts to quantify, providing managers an opportunity to utilize strategic non-GAAP exclusions, that are harder for external entities to detect, to meet-or-beat earnings benchmarks. Therefore, it is not clear whether managers are more or less likely to meet-or-beat earnings benchmarks when firms experience natural disasters. Utilizing a novel database covering comprehensive natural disasters occurring in the United States, I examine whether managers are more likely to meet-or-beat earnings benchmarks when firms experience natural disasters. Natural disasters are well suited for earnings benchmark study for the following reasons. First, natural disasters are external shocks that are exogenous to firm and managerial characteristics (Dessaint and Matray 2017). Previous evidence of earnings management study 1 Prior research finds that managers have strong incentives to achieve earnings targets. For example, previous evidence suggests a disproportionally high number of firms reporting earnings per share that meet or slightly exceed these earnings benchmarks. (e.g., Hayn 1995; Burgstahler and Dichev 1997; Degeorge et al., 1999). 1 could have potential endogeneity problems such as reverse causality or unobserved heterogeneity because a firm’s likelihood of meeting-or-beating earnings benchmark is highly correlated with many firm and managerial characteristics.2 On the other hand, my findings with respect to a firm’s strategic accounting choice followed by natural disasters cannot easily to be attributed to firm or managerial characteristics (Dessaint and Matray 2017). Second, natural disasters provide an ideal setting to observe differential managerial incentives to achieve the three earnings benchmarks (i.e., zero earnings, last year’s earnings, and analyst earnings forecasts). While prior research consistently documents that mangers tend to avoid missing the three earnings benchmarks, there is very little evidence on managers’ differential motivations