Analyst Coverage and Earnings Management: Quasi-Experimental Evidence

Do securities analysts serve as effective external monitors, or do they pressure managers to focus on short-term performance? To explore this question, we study how securities analysts influence managers' use of different types of earnings management. To isolate causality, we employ a quasi-experiment that exploits exogenous reductions in stock-level coverage resulting from brokerage house mergers. We find that managers respond to a loss of coverage by decreasing real activities manipulation, while increasing their use of accrual-based earnings management. These effects are attributable to firms with low initial analyst coverage and also vary systematically with proxies for the costs of earnings management. Our causal evidence suggests that managers use real activities manipulation to enhance short-term performance and meet analyst forecasts, effects that are not uncovered when focusing solely on accrual-based earnings management.