Does Earnings Management Matter for Strategy Research?

Strategic management research often uses accounting data to measure organizational performance, despite well known concerns that earnings management could obscure the link between managerial actions and true performance. We apply new methods from the econometric literature on bunching to estimate that around 15 percent of all firm-year observations in Compustat manipulate earnings to achieve positive profitability. Using the same methods, we show that cash-based performance measures are less susceptible to manipulation. Finally, we demonstrate that the choice of accrual versus cash-based performance measures “matters” for two classic strategy research questions: a profitability variance decomposition, and an analysis of persistence in firm performance. These findings highlight the potential importance of exploring robustness to alternative performance measures, and thereby contribute to an emerging literature that reconsiders the link between theoretical constructs and the various performance metrics available to empirical researchers.