Earnings management through financing activities: Evidence from early debt extinguishments

We investigate whether early debt extinguishments, a financing activity, are used to manage earnings after the introduction of SFAS No. 145 in 2002. This standard changes the reporting rules of gains and losses from early debt extinguishments, which are now included in income from continuing operations. This shift in reporting rules provides firms with a potential opportunity to manage income from continuing operations, which is valued more by investors than below the line items. We hypothesize and find that gains from early debt extinguishments are positively associated with the magnitude of shortfall from earnings benchmarks and the propensity to meet or beat earnings benchmarks after the adoption of SFAS 145. Thus, our findings suggest unintended consequences of the SFAS No. 145, which may have implications for policy makers.