Camouflaged Earnings Management



In recent years, there has been increased scrutiny of financial reporting, and analysts and investors have devoted more attention to indicators of potential earnings management, in particular, to cash and accruals relative to earnings and sales. We assert that, in response, firms have increased their focus on cash management aimed at aligning these variables, which has made the detection of earnings management more difficult. We define and develop indicators of camouflaged earnings management and use them empirically to test whether the alignment of cash and accruals with earnings and sales has intensified following the legislation of the Sarbanes-Oxley Act. The empirical results are all in line with, and reinforce, our assertion. An interesting implication is that prior studies’ documented decrease in accrual-based earnings management post-SOX may have been the result of camouflaged earnings management, and not necessarily an actual decrease in accrual-based earnings management. Our findings also suggest that any comprehensive investigation of earnings management may benefit from considering the possibility of camouflaged earnings management.