The Effects of Accelerated Revenue Recognition on Earnings Management and Earnings Informativeness: Evidence from SEC Staff Accounting Bulletin No. 101

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Abstract
The SEC issued Staff Accounting Bulletin (SAB) No. 101 to address its concern that firms were masking true performance by managing earnings using accelerated revenue recognition. Critics of this Accounting Bulletin stated that it would eliminate industry-accepted revenue recognition practices and reduce the quality of reported earnings. The FASB's revenue recognition discussions echo these concerns stating that revenues recorded prior to the completion of the earnings process contain value-relevant information about future performance. This paper investigates these two hypotheses using a sample of firms that accelerated revenue recognition prior to SAB No. 101 adoption (SAB 101 firms) and a matched set of firms that were unaffected by this regulation (unaffected firms). Our earnings distribution tests indicate that SAB 101 firms are more likely to meet earnings benchmarks. Specifically, we find that, in the pre-adoption period, SAB 101 firms report fewer small negative and more small positive earnings than they do in the post-adoption period and than do unaffected firms in the pre-adoption period; SAB 101 firms report fewer small negative and more small positive earnings changes in the pre-adoption period compared to the post-adoption period. We also document that SAB 101 firms are more likely to have weaker corporate governance and more likely to have financial covenants, providing them with greater incentives to manage earnings. However, we find that the association between earnings and future cash flows and between unexpected earnings and earnings announcement period returns were higher for SAB 101 firms than for unaffected firms in the preadoption period, indicating higher earnings informativeness for SAB 101 firms. These associations declined for SAB 101 firms in the post-adoption period, suggesting that SAB No. 101 caused a decline in earnings informativeness. Overall, our results suggest that, although the revenue recognition practices targeted by SAB No. 101 have been used by some firms to manage earnings, the regulation's prohibition of revenue recognition prior to completion of the earnings process, on average, results in less informative earnings since these unearned revenues provide value-relevant information.

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