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Quadrophobia: Strategic Rounding of EPS Data

Published online by Cambridge University Press:  24 November 2022

Nadya Malenko*
Affiliation:
University of Michigan Ross School of Business
Joseph A. Grundfest
Affiliation:
Stanford University Law School [email protected]
Yao Shen
Affiliation:
City University of New York Baruch College [email protected]
*
[email protected] (corresponding author)
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Abstract

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Managers’ incentives to round up reported earnings per share (EPS) cause an underrepresentation of the number 4 in the first post-decimal digit of EPS, or “quadrophobia.” We develop a novel measure of aggressive financial reporting practices based on a firm’s history of quadrophobia. Quadrophobia is pervasive, persistent, and successfully predicts future restatements, Securities and Exchange Commission enforcement actions, and class action litigation. It is more pronounced when executive compensation is more closely tied to the stock price and when the firm anticipates violating debt covenants. Quadrophobia is especially strong when rounding-up EPS allows firms to meet analyst expectations, and investors seem not to see through this behavior.

Type
Research Article
Creative Commons
Creative Common License - CCCreative Common License - BYCreative Common License - NCCreative Common License - ND
This is an Open Access article, distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives licence (https://creativecommons.org/licenses/by-nc-nd/4.0), which permits non-commercial re-use, distribution, and reproduction in any medium, provided that no alterations are made and the original article is properly cited. The written permission of Cambridge University Press must be obtained prior to any commercial use and/or adaptation of the article.
Copyright
© The Author(s), 2022. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

We are grateful to an anonymous referee for suggestions that have substantially improved the article. We are also grateful to Anat Admati, Robert Daines, Ian Gow, Jarrad Harford (the editor), Elaine Harwood, Daniel Ho, Alan Jagolinzer, David Larcker, Andrey Malenko, Maureen McNichols, Sugata Roychowdhury, David Solomon, Roman Weil, Anastasia Zakolyukina, and participants of the Stanford Law Review Symposium on corporate governance for valuable comments; to Alan Jagolinzer, David Larcker, Anastasia Zakolyukina, and the Stanford Law School/Cornerstone Research Securities Class Action Clearinghouse for providing us with the data; to Hedieh Rashidi Ranjbar for research assistance; and to the Rock Center for Corporate Governance for financial support. The views expressed in the article are views of the authors and do not represent the views of Cornerstone Research or Stanford Law School.

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