An Institutional Perspective on Firms' Efforts to Fulfill the Earnings Cult

This paper draws on institutional theory to advance and test a theoretical framework that explores publicly traded firms’ efforts to strategically maneuver an institutionalized prescription linked to the logic of shareholder-value maximization. Using the case of earnings management as a financial device mobilized to meet security analyst forecasts, we advance that firms’ efforts to meet an institutionalized prescription through strategic means can trigger a negative feedback loop of intensified future conformity expectations and increased penalty for non-conformity, which can lead firms to eventually resort to a compensatory action. Specifically, we advance that when the shareholder-value maximization logic emerged publicly traded firms were induced to conform to its prescriptions but also learned how to strategically manage them. Such a strategic response, while initially benefiting firms, can lead to unintended long-term consequences. As more firms manage to give the appearance of conformity by reporting the earnings number the market forecasted, they reinforce the expectation that firms should meet their earnings targets, putting first firms under greater conformity pressure, resulting then in an increasing penalty for non-compliance, and inducing them finally to appease dissatisfied market participants through compensatory action. We test our theoretical framework using a sample of large publicly traded firms from 1986 to 2006. We demonstrate that by performing according to analyst expectations, firms contribute to the institutionalization of the meet-analyst-forecasts prescription. In doing so, they strengthen the salience of the meet-analyst-forecasts prescription and, thus, market participants’ belief that firms should meet analyst forecasts. When they can no longer satisfy these increasing expectations, they come under major pressures and are induced to engage in asset divestiture, as a compensatory measure, particularly when most other firms successfully meet forecasts. By accounting for this dynamic relationship between the shareholder-value maximization logic and firms’ strategic use of a financial device to meet a prescription of this logic, our research reveals that while such strategic action can lead to short-term positive effects, they can eventually result in a backlash against firms. These findings lead us to derive implications for research on institutional theory and corporate strategy.