The Use of Advertising Activities to Meet Earnings Benchmarks: Evidence from Monthly Data

Abstract

Using a unique and comprehensive data set of monthly information on advertising spending in media outlets, we examine whether managers engage in real earnings management to meet quarterly financial reporting benchmarks. We extend prior literature by: (1) examining quarterly as opposed to annual earnings benchmarks and separating advertising from other expenses, which allows us to incorporate advertising’s unique characteristics; (2) exploring the possibility that managers could either reduce or boost advertising to increase chances of meeting an earnings benchmark; (3) investigating the timing, within a fiscal quarter, of altered advertising spending; and (4) analyzing actual activities as opposed to inferring them from reported expenses, which could also be influenced by accrual choices. Our analysis suggests that managers reduce their advertising spending to achieve the financial reporting goals of avoiding losses, avoiding earnings decrease, and meeting analysts’ forecasts. We find some evidence that advertising spending increases during the third month of a fiscal quarter. This increase is stronger for managers who have incentives to meet earnings benchmarks and whose firms have higher margins. We find no evidence of an increased tendency to alter advertising spending after the Sarbanes-Oxley Act.