The Upside of Loss Aversion: Evidence From Financial Reporting Loss Avoidance

This study provides evidence that managerial loss avoidance is one cause of the zero‐earnings discontinuity and that investor loss aversion is a plausible explanation for diversity in the appearance of that discontinuity. de la Rosa and Lambertsen in 2022 theoretically show that when investors are loss averse, the earnings discontinuities proposed by Guttman et al. in 2006 emerge at investor reference points and are an increasing function of loss aversion. In this study, I test these propositions using a sample drawn from 49 countries in which cross‐country differences in loss aversion are measurable. Net income distributions exhibit significant discontinuity at zero earnings only among countries ranked high in loss aversion. Multivariate analysis corroborates that the firm‐level likelihood of loss avoidance is also an increasing function of loss aversion. Consistent with loss aversion plausibly impacting loss avoidance through a pricing effect, the market penalty for missing the zero‐earnings threshold is also an increasing function of loss aversion. Additional analyses test competing theories on whether managers’ loss aversion facilitates loss avoidance through stronger performance or opportunistic reporting. These results suggest that performance (opportunistic reporting) plays a more extensive role in loss avoidance in more loss‐averse (less loss‐averse) countries.