Defying Gravity: Costly Signaling to Mislead or to Inform?
AbstractWhile it is generally maintained that earnings management can occur to inform as well as to mislead, evidence that earnings management informs has been scarce, and evidence that credibility increases with signal costliness inexistent. We provide evidence that firms use discretion over financial reporting and real activities to report higher earnings on lower sales from continuing operations. Although these firms defy gravity artificially, we show that the upwards earnings management informs rather than misleads investors. We find that firms that defy gravity (1) report higher future earnings and cash flows, (2) earn higher one-year-ahead abnormal returns, (3) have a positive market reaction to the defying gravity earnings announcement, and (4) their CEOs are more likely to be net buyers in the year preceding the defying gravity event. We also show that the upwards earnings management signal is more credible when it is more costly to achieve: Defying gravity firms perform better when they bear the opportunity loss of not taking a big bath in times of crisis — years where poorer performance can be blamed on economy-wide shocks, and when they have fewer degrees of freedom to report higher earnings.
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Bibliographic InfoPaper provided by HEC Paris in its series Les Cahiers de Recherche with number 1024.
Length: 48 pages
Date of creation: 04 Nov 2013
Date of revision:
Earnings Management; Signaling; Informativeness; Opportunism; Credibility;
Find related papers by JEL classification:
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
- M40 - Business Administration and Business Economics; Marketing; Accounting - - Accounting - - - General
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- NEP-ALL-2013-12-29 (All new papers)
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