Earnings expectations and employee safety

https://doi.org/10.1016/j.jacceco.2016.12.002Get rights and content

Abstract

We examine the relation between workplace safety and managers’ attempts to meet earnings expectations. Using establishment-level data on workplace safety from the Occupational Safety and Health Administration, we document significantly higher injury/illness rates in firms that meet or just beat analyst forecasts compared to firms that miss or comfortably beat analyst forecasts. The higher injury/illness rates in firms that meet or just beat analyst forecasts are associated with both increases in employee workloads and in abnormal reductions of discretionary expenses. The relation between benchmark beating and workplace safety is stronger when there is less union presence, when workers’ compensation premiums are less sensitive to injury claims, and among firms with less government business. Our findings highlight a specific consequence of managers’ attempts to meet earnings expectations through real activities management.

Introduction

Accounting research has long shown that managers face pressure to meet earnings benchmarks and that they react to this pressure by manipulating accruals and real activities when their firm is at risk of missing benchmarks (e.g., Dechow et al. 2010, §5.5). Survey evidence suggests that, in order to meet benchmarks, managers prefer taking real actions over manipulating accruals (Graham et al., 2005). Empirical studies provide strong evidence for real activities management (e.g. Roychowdhury, 2006; Cohen et al., 2008). Importantly, real activities management is difficult for investors to detect in the short run (Kothari et al., 2016) but potentially has negative consequences for firms’ long-run performance (e.g., Bhojraj et al., 2009; Cohen and Zarowin, 2010). In this study, we provide evidence of a previously undocumented consequence of real activities management to meet earnings benchmarks – compromises in workplace safety. In particular, we show that benchmark beating is associated with higher workplace injuries and that the strength of this association varies with employee workloads and discretionary expenses that include safety-related expenditures.

Earnings benchmarks can relate to workplace safety in at least two ways. First, if managers believe that the firm may miss expectations under the ordinary course of business, they may increase employees’ workloads or pressure them to work faster. In response, employees can compromise safety by overexerting themselves or by circumventing safety procedures that slow the flow of work. Second, managers may cut explicit and implicit safety costs, such as the costs of maintaining equipment and training employees, in their attempts to report higher earnings. Along these lines, Graham et al. (2005) report that some CFOs admit to cutting maintenance spending in order to meet earnings benchmarks. To the extent managers take such actions, workplace safety will deteriorate when firms struggle to meet expectations.

We examine whether firms suspected of managing earnings to meet expectations exhibit higher workplace injury rates than other firms. We follow prior research on earnings management and define firms that meet or just beat expectations as suspect firms (e.g., Burgstahler and Dichev, 1997; Degeorge et al., 1999). Using establishment-level (e.g., store or factory) injury data from the Occupational Safety and Health Administration (OSHA) for the 2002–2011 period, we find that about one in every 24 employees is injured in firms that meet or just beat analyst earnings forecasts, compared to about one in 27 in firms that miss or comfortably beat forecasts. In multivariate analyses, where we control for a variety of establishment- and firm-level characteristics as well as establishment (or firm) and year fixed effects to account for unobservable factors, we find that the association between benchmark beating and injury rates remains statistically and economically significant. For example, controlling for other factors, injury rates are five to fifteen percent higher in periods where a firm meets or just beats analyst forecasts than in other periods.

We provide evidence that the relation between benchmark beating and workplace safety likely stems from two types of real actions that managers take: high workloads and cuts to safety-related expenditures. We utilize production per employee and revenue per employee as measures of employee workloads, and abnormal discretionary expenses per employee to gauge cuts to safety-related expenditures. We find that injury rates are more strongly associated with production per employee in firms that meet or just beat forecasts. We also find evidence that injury rates are higher when firms that meet or just beat forecasts have abnormally low per-employee discretionary expenditures.1 Taken together, the evidence suggests that both pressure to increase worker productivity and cuts to safety-related expenditures contribute to the relation between benchmark beating and workplace safety.

We use three settings to examine cross-sectional variation in the relation between benchmark beating and workplace safety. First, we find that the relation is weaker in industries with high union membership. This is consistent with unions’ aim to ensure reasonable workloads, work speed, and safety (Kaufman, 2005). It is also consistent with the findings in the literature that, compared to non-union workers, union workers are less likely to perceive that taking risks is a part of their job (Gillen et al., 2002), and unionization leads to fewer workplace injuries (Morantz, 2013). Consistent with unions’ goal of workplace safety, our evidence suggests that unions mitigate the extent to which pressure to meet earnings expectations translates into reduced safety.

Second, we find a weaker relation between benchmark beating and workplace safety when workers’ compensation insurance premiums are more sensitive to injury claims. Workers’ compensation insurance is a state-mandated program and its premiums are primarily determined by state requirements. Insurance premiums depend, in part, on a multiplier based on the employer's workplace safety record. A given change in the multiplier thus has a greater dollar impact on premiums when the baseline insurance premium is higher. We test and find that the association between benchmark beating and workplace safety is weaker in establishments that are located in states where each additional injury has a higher impact on workers’ compensation premium.

Third, we utilize government contracting as an incentive for keeping safer work environments. Government contracts typically include terms that prohibit bids from firms deemed to have unsafe work environments. Consistent with the government contractors’ heightened focus on safety, we find that the relation between benchmark beating and workplace safety is weaker for firms that do more business with the government.

In our main analyses, we focus on analyst forecasts as our measure of earnings expectations since prior research indicates that meeting analyst forecasts is a more important benchmark than meeting prior year's earnings or avoiding losses (Dechow et al., 2003), and that the market perceives missing analyst forecasts as a more negative signal than a decrease in year-over-year earnings (Brown and Caylor, 2005). In additional tests, we replicate our primary analyses for the zero-earnings and zero-earnings-change benchmarks. We find higher injury rates in suspect firm-years identified by zero-earnings-changes, but not for zero-earnings. This may be because after the passage of Sarbanes-Oxley Act (SOX) in 2002, the zero-earnings discontinuity, and to a lesser extent discontinuity around prior year's earnings, have dissipated whereas the discontinuity around analyst forecasts remain (Gilliam et al., 2015).

Our study is related to the literature studying the forms and consequences of earnings management via real activities. Extant research finds that managers cut research and development (e.g., Baber et al., 1991), advertising (e.g., Cohen et al., 2010), selling, administrative and general expenditures, and engage in over-production (e.g., Roychowdhury, 2006) in order to meet earnings benchmarks, and that such activities potentially negatively affect a firm's long-run operating performance (e.g., Bhojraj et al., 2009; Cohen and Zarowin, 2010). Our study adds to this literature by documenting a novel and potentially opaque consequence of managing earnings via real activities – compromises in workplace safety. Our findings highlight that costs of real activities management can accrue not only in monetary terms but also in terms of employee health. The effects we document may represent the “tip of the iceberg” in terms of the overall employee health since OSHA collects data on only relatively serious and physical injuries/illnesses such as those that require hospitalization, days away from work, or job transfers. Additionally, in the light of recent findings that investors face greater difficulty in detecting earnings management via real activities (Kothari et al., 2016), our results suggest that timely disclosures about workplace safety can serve as signals to investors of certain forms of real activities management. While some firms are considering providing such disclosures (e.g., Silverman, 2016), these disclosures are typically not available to investors on a timely basis and in a systematic manner.

We also contribute to the literature on workplace safety and firms’ financial condition. Cohn and Wardlaw (2016) predict and find that workplace injury rates are associated with high leverage and with negative cash flow shocks. In a study of the operational performance of restaurant chains in Florida, Bernstein, and Sheen (2016) find that restaurants become safer and cleaner following private equity buyouts. We focus on managerial attention to earnings targets and find that it diminishes managers’ focus on workplace safety. Also related to our study, Rose (1990) finds a link between the safety of airline customers and the overall financial health of airlines, and Matsa (2011) finds that in the supermarket industry, competition increases service quality. Unlike Rose (1990) and Matsa (2011), we focus on employee safety rather than service/product quality, and earnings benchmarks rather than the overall financial health of the firm. Prior studies also find that accidents and absences are associated with high capacity and labor utilization (See survey by Pouliakas and Theodossiou (2013)). The stronger association we document between production per employee and injury rates in suspect firm-years relative to non-suspect firm-years is consistent with an association between workplace safety and high labor utilization.

Our findings do not speak to the magnitude of net welfare effects of compromises in workplace safety on firms or employees. The socially optimal injury rate likely exceeds zero, and such compromises could overall be desirable if the benefits exceed the costs. Nevertheless, the negative impact of such compromises on employee health represents a cost for the firms to the extent that it results in higher wage demands, fines, litigation, increased insurance premiums, and negative publicity, and a cost to employees in the form of pain, lost wages, and, in extreme cases, death.

Section snippets

Safety regulation and incentives for workplace safety

The Occupational Safety and Health Administration (OSHA) regulates workplace safety for most private sector employers in the United States. Exceptions include employers subject to safety regulation from other federal agencies, such as the Mine Safety and Health Administration and the Federal Aviation Administration. OSHA promulgates standards including equipment safety, communication of hazards, and training programs.2 It also

Research design

We conduct our analysis using establishment-level data from the ODI survey. Our dependent variable is the count of injuries, and we accordingly use a count model to estimate the relation between employee safety and the pressure to meet earnings benchmarks. Based on Burgstahler and Dichev (1997)’s findings on earnings management, we measure periods of pressure to meet benchmarks (Suspect) as firm-years that meet or just beat their earnings benchmarks. Prior literature provides evidence

Data

Our sample is comprised of establishments from the ODI that can be linked to firms in Compustat annual file for the 2002–2011 period. We begin our sample period in 2002 because OSHA simplified and changed its recording criteria for injuries and illnesses and the coverage of industries that year, and values for prior years are not comparable. OSHA discontinued the ODI in 2011 due to funding cuts. We manually match establishments from the ODI to firms in Compustat based on names. In particular,

Relation between meeting/beating expectations and injury/illness rates

We begin our analysis by visually inspecting the relation between total case rate and earnings surprises. We define earnings surprise using earnings per share and analyst forecast data from I/B/E/S, and calculate it as the difference between the actual earnings per share and the average of all analysts’ latest forecast made within [-180, -4] day window prior to the earnings announcement date, rounded to the nearest cent. We define firms that are suspected of engaging in earnings management as

Cross-sectional differences in the relation between benchmark beating and workplace safety

In this section we present cross-sectional tests of the relation between benchmark beating and workplace safety. We consider three factors that could affect managers’ flexibility and incentives to compromise worker safety. First, we consider unionization as a proxy for employees’ power to ensure safe work environments, even when the company faces pressure to meet benchmarks. Second, we consider costs of workers’ compensation insurance as a proxy for costs firms can face for compromising

Alternative definition of earnings benchmarks

In our main analyses, we focus on analyst forecasts as the earnings benchmark. In untabulated analyses, we reexamine the relation between employee safety and benchmark beating using prior year's earnings and zero-earnings as alternative earnings benchmarks. For the prior year's earnings benchmark, we follow Burgstahler and Dichev (1997) and Dechow et al. (2003) and define suspect firm-years as those for which the difference between current year and prior year net income scaled by beginning of

Conclusion

Using establishment-level injury data collected by the Occupational Safety and Health Administration, we provide evidence that managers seeking to meet or beat earnings expectations compromise workplace safety, such as by cutting safety related expenditures or increasing workloads. We find that one in 24 employees are injured in firm-years that meet or just-beat analyst forecasts compared to one in 27 in other firm-years. The difference between two groups remains statistically and economically

References (60)

  • T. Kniesner et al.

    Regulating occupational and product risks

  • D. McCaughey et al.

    The negative effects of workplace injury and illness on workplace safety climate perceptions and health care worker outcomes

    Saf. Sci.

    (2013)
  • S. Roychowdhury

    Earnings management through real activities manipulation

    J. Account. Econ.

    (2006)
  • W. Viscusi

    Regulation of health, safety, and environmental risks

  • R. Albuquerque et al.

    Corporate Social Responsibility and Firm Risk: Theory and Empirical Evidence

    (2015)
  • W. Baber et al.

    The effect of concern about reported income on discretionary spending decisions: the case of research and development

    Account. Rev.

    (1991)
  • Bernstein, S., Sheen, A., 2016. The Operational Consequences of Private Equity Buyouts: Evidence from the Restaurant...
  • S. Bhojraj et al.

    Making sense of cents: an examination of firms that marginally miss or beat analyst forecasts

    J. Finance

    (2009)
  • L. Boden

    Running on empty: families, time, and workplace injuries

    Am. J. Public Health

    (2005)
  • L. Boden et al.

    Economic consequences of workplace injuries and illnesses: lost earnings and benefit adequacy

    Am. J. Ind. Med.

    (1999)
  • L. Brown

    A temporal analysis of earnings surprises: profits versus losses

    J. Account. Res.

    (2001)
  • L. Brown et al.

    A temporal analysis of quarterly earnings thresholds: propensities and valuation consequences

    Account. Rev.

    (2005)
  • A. Call et al.

    Short-term earnings guidance and accrual-based earnings management

    Rev. Account. Stud.

    (2014)
  • A. Cameron et al.

    Count panel data

  • C. Caruso et al.

    Overtime and Extended Work Shifts: Rcent Findings on Illnesses, Injuries, and Health Behaviors. (DHHS (NIOSH) Publication No. 2004-143)

    (2004)
  • D. Cohen et al.

    Real and accrual-based earnings management in the pre- and post-Sarbanes-Oxley periods

    Account. Rev.

    (2008)
  • D. Cohen et al.

    The use of advertising activities to meet earnings benchmarks: evidence from monthly data

    Rev. Account. Stud.

    (2010)
  • Cohn, J., and Wardlaw, M., 2016. Firm constraints and workplace safety. Journal of Finance 71(5),...
  • P. Dechow et al.

    Why are earnings kinky? An examination of the earnings management explanation

    Rev. Account. Stud.

    (2003)
  • F. Degeorge et al.

    Earnings management to exceed thresholds

    J. Bus.

    (1999)
  • Cited by (99)

    • Shareholder litigation and workplace safety

      2023, Journal of Corporate Finance
    View all citing articles on Scopus

    We thank David Aboody, Umit Gurun, Jack Hughes, Frank Heflin (discussant), Sugata Roychowdhury (the referee), Brett Trueman, Joanna Wu (the editor), and workshop participants at McGill University and the AAA Annual Meeting for their helpful comments. We also thank Jaye Bupp and Dave Schmidt from the Occupational Safety and Health Administration, Office of Statistical Analysis for providing us the data on workplace safety.

    View full text