Earnings management through real activities choices of firms near the investment–speculative grade borderline

Abstract

We examine whether manufacturing firms manage earnings through real activities for credit rating concerns. By using Standard & Poor’s Rating Service (S&P) credit rating data between 1989 and 2009, we find that manufacturing firms in the rating categories near the investment–speculative borderline, that is, BBB and BB ratings, choose the most aggressive income-increasing real operating activities. The credit rating agency does not appear to discount the managed portion of earnings if it is managed through real activities. Our results suggest that the investment–speculative-grade borderline created by the explicit use of this dichotomy in various regulations and practices is an important threshold that influences management’s real earnings management decisions.