Industry earnings performance and firms\u27 accrual decisions

The relative performance evaluation theory suggests that there are benefits associated with evaluating managers on the basis of their relative performances. Prior studies provide theoretical support that an optimal compensation contract is based on a combination of two performance measures: a firm\u27s own performance and the performance of a peer group. Thus, we expect that managers may be interested in earnings performances of peer firms along with their firm\u27s earnings performance Therefore, this research examines whether a firm\u27s relative earnings performance (REP) affects the discretionary accrual decisions of the firm which belongs to the industry. The results from this research show that a firm\u27s abnormal accruals (AA) are positively associated with industry AA. The results also show that firms tend to adjust their accruals to make their earnings look comparable to earnings of their industry peers. Specifically, a firm\u27s REP has explanatory power over its own earnings in explaining the level of AA. Also, the results provide evidence that the relation between AA and REP varies between over- and underperforming firms relative to their industry peers. That is, firms which do worse than their industries tend to select more significant income-increasing AA than those doing better. In particular, the results show that firms reporting their earnings late relative to other firms in the same industry adjust their accruals to a greater extent than those reporting earnings early, and that late announcers with poor REPs tend to have incrementally higher accruals than do other firms. Furthermore, simultaneous equation (2SLS and 3SLS estimations) results show that four (accounts receivable, inventory, accounts payable, and depreciation) out of six components of AAs examined are significantly related to REP and that firms tend to trade off between some accrual components when they make accrual decisions