Does Earnings Management Matter for Strategy Research?∗

Strategic management research frequently seeks to explain variation in organizational performance using metrics such as accounting profits scaled by firm assets (ROA). A concern with accrual-based accounting methods, perhaps best illustrated by a large discontinuity in the distribution of ROA around zero for U.S. public firms, is that operational and accounting practices will artificially inflate/deflate accounting profit. In this manuscript we establish that such earnings management is common, introduces non-classical noise, and distorts our understanding of broad drivers of firm performance. We conclude with analysis showing that an alternative performance measure, Cash Flows from Operations on Assets (OCFOA), offers a robust vehicle for checking results using accounting profits.