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Strategic Earnings Announcement Timing and Fraud Detection

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Abstract

This study investigates whether firms with fraudulent financial reporting time their earnings announcements strategically and finds that fraudulent firms are more likely to disclose their earnings in the after-market hours during their fraud periods to postpone fraud detection. Cross-sectional tests show that firms with lower visibility are more likely to adopt and benefit from this timing strategy. In addition, fraudulent firms are found to time their conference calls strategically and package their earning news with forecasts to flood the market with information and lower the fraud detection rate. Results also show that unethical managers may benefit from insider trading when their firms use a timing strategy to lower the detection rate. This study sheds light on a potential strategy that unethical managers may adopt to camouflage their fraudulent financial reporting. These results are robust to a variety of settings of samples and model specifications.

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Notes

  1. There are three time periods (before, during, and after trading) for firms to disclose earnings news. As of December 2015, more than half of publicly traded firms in our sample announce earnings after the closing bell (after-market hours). This is consistent with DeHaan et al. (2015), in which they report that more than 40% of earnings announcements are made in after-market hours each year from 2000 to 2011.

  2. Excessive attention is normally triggered by abnormal corporate behaviors and suspicious price moves; it may occur at any time and is not restricted to the period with limited investors’ attention.

  3. The Friday evening effects are found by Michaely et al. (2016a). They show that managers tend to announce bad earnings news strategically on Friday evenings to benefit from reduced market scrutiny and delayed market response.

  4. Normally, it is difficult to identify the so-called ethical manager ex ante. In untabulated results, we use a dummy variable Violations that equals one if a firm has at least one non-financial violation during the sample period and zero otherwise. We also use the total number of non-financial violations (Num (Violations)) in the previous year as an alternative proxy for the ethical level of managers. Ethical managers are defined as managers with few or no non-financial violation records. By examining the moderating effects of ethics on managers’ tendency to use the timing strategy and its effect on fraud detection, we find that previously ethical managers are more effective at using the timing strategy to delay fraud detection. This finding might be considered an additional contribution of this study.

  5. Karpoff et al. (2017) show that the fraud indicator RES_FRAUD in the Audit Analytics database misses many restatement announcements. In addition, using only this indicator would result in a sample that is too small to conduct our tests.

  6. In untabulated results, we compare all of the variables used in our analysis between fraudulent and non-fraudulent reporting firms in the pooled sample and show that these two groups are significantly different in several firm characteristics. For example, fraudulent reporting firms tend to be smaller and have lower analyst coverage, less institutional ownership, and longer reporting lags than non-fraudulent firms.

  7. Details of the PSM approach can be found in the Estimation section.

  8. Since we use a different sample period from DeHaan et al. (2015), we also explore quarterly earnings announcement timing in the sample period from 1990 to 2015 and find similar results as those reported by DeHaan et al. (2015).

  9. From Panel A, 14.5% = 9.1% + 5.4% (i.e., % of firms switching to AMC from before and during).

  10. In untabulated results, we perform a regression test to validate our findings. we define Other-AMC as an indicator that equals 1 if an earnings announcement is switched to after-market hours from other time slots in the current year, and 0 otherwise. We regress this variable on FraudulentRep and necessary controls, as done for AMC. The result shows that the estimated coefficient of FraudulentRep is positive and statistically significant (\(\beta\) = 0.122, p < 0.1), suggesting that fraudulent firms are more likely to switch the timing of their earnings releases to after-market hours during fraud years than the control firms.

  11. If a firm commits multiple restatements during the sample period, we keep all of them in the empirical tests. The results still hold if we only keep the first restatement for each firm.

  12. As an alternative measure, AMCHide is given a value of one if a firm makes at least half of its earnings announcements during after-market hours during fraud years, and zero otherwise. The results remain statistically unchanged.

  13. See Appendix A for detailed variable definitions.

  14. The economic significance should be interpreted carefully since other factors may also extend or shorten the discovery period for fraud. For instance, as suggested by the anonymous reviewer, 8-K filings require firms to disclose material misstatements within four business days upon discovery, whereas non-material misstating firms might choose other channels and reveal misstatements with a much longer delay. We thank the reviewer for this comment.

  15. The authors appreciate this suggestion from the anonymous reviewer.

  16. The results are similar if AMCHide equals one if a firm makes at least half of its earnings announcements during after-market hours during the violation periods.

  17. For control variables that are missing at the start of the fiscal year of the filing date, we replace missing values with values in the fiscal year closest to the filing year to maximize the sample size.

  18. The sample beginning year is extended to 1990 in order to obtain a larger sample size.

  19. To resolve the confounding effect of multiple restatements on earnings announcement timing, we keep only the first restatement case for each company.

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Authors and Affiliations

  1. Renmin University, Beijing, China

    Xin Cheng

  2. Rutgers Business School, Newark, USA

    Dan Palmon

  3. Southwestern University of Finance and Economics, Chengdu, China

    Yinan Yang

  4. Tsinghua University, Beijing, China

    Cheng Yin

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  1. Xin Cheng
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  2. Dan Palmon
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  3. Yinan Yang
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  4. Cheng Yin
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Correspondence to Cheng Yin.

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Appendices

Appendix A

See Table 12.

Table 12 Variable definitions
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Appendix B

See Table 13.

Table 13 Sample selection
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Appendix C

See Table 14.

Table 14 Propensity-score matching
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Cheng, X., Palmon, D., Yang, Y. et al. Strategic Earnings Announcement Timing and Fraud Detection. J Bus Ethics 182, 851–874 (2023). https://doi.org/10.1007/s10551-021-05029-2

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