Evidence on the tradeoff between real manipulation and accrual manipulation

I study whether managers use real activities management (real manipulation) and discretionary accruals management (accrual manipulation) as substitutes in managing earnings, and I study the order that managers make these decisions. I find that managers determine real manipulation before accrual manipulation. Based on this result, I use an empirical model that captures the sequentiality of real and accrual manipulations to test the tradeoffs between the two. The results of the broad sample tests are consistent with managers using real and accrual manipulations as substitutes. In a small sample test examining firms subject to securities class actions, I examine whether real and accrual manipulations change over time with changes in litigation risk. Consistent with managers using real and accrual manipulations as substitutes, I find that managers switch from accrual manipulation to real manipulation after lawsuit filings.