In Practice Managing Earnings

Companies, which have seen the effect on their stock prices of not meeting analyst expectations on earnings, have learned over the last decade to manage their earnings. Accounting standards, strict as they are for U.S. companies, still allow some leeway for firms to move earnings across periods by delaying revenues or expenses, or choosing a different accounting method. Companies like Microsoft not only work at holding down expectations on the part of analysts following them, but also use their growth and flexibility to move earnings across time to beat expectations. In January 1997, Microsoft reported earnings per share of 57 cents for the quarter, beating consensus estimates of 51 cents per quarter, the 41st quarter out of 42 that Microsoft had beaten expectations.

The phenomenon of managing earnings has profound implications for a number of actions that firms may take, from how they sell their products and services, to what kinds of projects they take or firms they acquire and how they account for such investments. While Microsoft has not been guilty of accounting manipulation and has worked strictly within the rules of the game, other companies which have tried to replicate its success have had to resort to far more questionable methods to report earnings that beat expectations.

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