A Rational Expectations Theory of the Kink in Earnings Reports
AbstractEmpirical evidence suggests that the distribution of earnings reports exhibits kinks. Managers manage earnings as if to meet exogenously pre-specified targets, such as avoiding losses and avoiding a decrease in earnings. This is puzzling because the compensation to managers at these pre-specified targets seems to be smooth. We propose a game theoretic model explaining this phenomenon. In our model, investors form expectations of such a manipulative behaviour by the manager. Given these expectations, the best response of the manager is to fulfill the investors’ expectations, resulting in a discontinuity in the distribution of earnings reports. Our model generates several new empirical predictions regarding the existence of the kink, its size and its location relative to the distribution of earnings reports.
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Bibliographic InfoPaper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4613.
Date of creation: Sep 2004
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Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G30 - Financial Economics - - Corporate Finance and Governance - - - General
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