Empirical tests of budget ratcheting and its effect on managers' discretionary accrual choices

Andrew J. Leone*, Steve Rock

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

56 Scopus citations

Abstract

In this paper, we investigate whether budgets ratchet. Using business-unit data from a large multinational corporation, we find evidence consistent with ratcheting where favorable budget variances result in performance budget increases that are larger than decreases associated with unfavorable variances of the same magnitude. We argue that under ratcheting, the cost of reporting positive transitory earnings surprises outweigh the short-term benefits of the current-period bonus. Consequently, we hypothesize that managers make income-decreasing discretionary accruals to offset transitory earnings surprises beyond the level expected under fixed budgets. Using a proxy for transitory earnings surprise, we find evidence consistent with this hypothesis.

Original languageEnglish (US)
Pages (from-to)43-67
Number of pages25
JournalJournal of Accounting and Economics
Volume33
Issue number1
DOIs
StatePublished - Mar 7 2002

Keywords

  • Bonus plans
  • Earnings management
  • Performance budgets
  • Ratchet effect
  • Ratchet principle

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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