The power of numbers: base-ten threshold effects in reported revenue
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Date
2016
Authors
Stice, Derrald
Stice, Earl K.
Stice, Han
Stice-Lawrence, Lorien
Journal Title
Journal ISSN
Volume Title
Publisher
Social Science Research Network (SSRN)
Abstract
We provide evidence that managers have a revealed preference for reporting total revenue
numbers just above base-ten thresholds (i.e., “round” numbers) of the form N × 10K. Examples are $10 million (1 × 107) and $4 billion (4 × 109). Our finding is consistent with a literature in psychology demonstrating that humans are susceptible to a cognitive bias associated with baseten reference points. However, we also document several rational explanations for this revenue management behavior on the part of managers. First, analyst revenue forecasts also exhibit this regularity, especially in early forecasts when greater uncertainty can potentially induce analysts to rely to a greater extent on heuristics, suggesting that managers may be managing reported revenue numbers to meet externally-determined base-ten-influenced benchmarks. In addition, the effect that we document is stronger for firms that face greater pressure to report high revenue
growth, while firms that exceed base-ten revenue thresholds for the first time benefit from
increased press coverage. Finally, we show that the revenue growth needed to stretch for a baseten threshold is not sustainable; firms that just exceed base-ten thresholds have lower subsequent revenue growth. Given that managers engage in extra, and, on average, unsustainable efforts to increase revenues to reach base-ten thresholds, our results suggest that revenue manipulation is even more pervasive than previously documented and that lenders, investors, auditors, and regulators should apply an extra degree of skepticism when a reported revenue number just exceeds a base-ten threshold.
Description
Keywords
revenue management, base-ten thresholds, analyst forecast heuristics, revenue quality
Citation
Stice, Derrald and Stice, Earl K. and Stice, Han and Stice-Lawrence, Lorien, The Power of Numbers: Base-Ten Threshold Effects in Reported Revenue (March 29, 2016). Available at SSRN: http://ssrn.com/abstract=2756306