Quarterly earnings management through R&D and accruals manipulation

The primary objective of this study is to investigate how quarterly R&D manipulation, by itself and together with quarterly accruals manipulation, helps managers to achieve their quarterly and annual earnings targets for a group of U.S. corporations. There are three parts to my study. The first part examines the impact of quarterly earnings targets on firms' quarterly R&D spending. I find results suggesting that firms in danger of reporting losses in their quarterly earnings (or reporting decreases from the same quarter of last year) tend to reduce their R&D spending in that quarter. Furthermore, firms with larger discretion over their R&D spending are better able to cut R&D to achieve their quarterly earnings targets than firms with smaller R&D flexibility.; Both accruals and R&D manipulation are shown to be useful in beating threshold, but little is known about how they work together to achieve managers' earnings targets. In the second part, I study whether managers use R&D and accruals manipulation as substitute mechanisms to boost quarterly earnings across the "avoid loss" threshold. Specifically, I argue that the tradeoff decision depends on the benefits and costs of using one or both earnings management tools as well as firms' relative discretion over the two choices. I provide evidence that the magnitude of R&D reduction is related to the magnitude of abnormal accruals for my sample firms in general. Furthermore, this substitutability effects are weaker for firms with smaller discretion over their quarterly R&D spending.; In the third part of the study, I argue that managers have both quarterly and annual earnings targets in mind when determining their quarterly R&D spending. This should at least apply to quarter 4, and possibly to earlier quarters as well. Specifically, in each quarter, if there is a shortfall in earnings with regard to one or both targets, managers may strategically adjust downward their quarterly R&D outlays. I test this hypothesis and find that firms consider both the annual and quarterly earnings targets in determining their quarter-4 R&D spending. In earlier quarters, managers are mainly concerned with the respective quarterly earnings thresholds.