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Managing Earnings by Manipulating Production: The Effects of Cost Structure and Inventory Valuation Method
Kirsten A. Cook, Texas A & M University
George Ryan Huston, Texas A & M University
Michael R. Kinney, Texas A & M University
ABSTRACT. This paper provides evidence that manufacturing firms manipulate production to manage earnings. Manufacturing firms can modify production to adjust Cost of Goods Sold through absorption costing mechanics for fixed production costs and (for LIFO users) to liquidate LIFO layers. We find that (1) firms adjust production to move earnings toward their targets, (2) firms with high fixed-cost ratios adjust inventory less than other firms, (3) the relation between earnings changes and inventory changes is weaker for LIFO firms, and (4) LIFO firms with high fixed-cost ratios behave like FIFO firms, increasing production (rather than liquidating LIFO layers) to increase earnings.
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