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Limited market participation and asset prices in the presence of earnings management

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Listed author(s):
  • Bo Sun
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Abstract

We examine the role of earnings management in explaining the properties of asset prices and stock market participation. We demonstrate that investors' uncertainty about the extent of manipulation can cause excess movements in stock price relative to fluctuations in output. When faced with information asymmetry about fundamentals in the presence of earnings management, investors demand a higher equity premium for bearing the additional risk associated with their payoffs. In addition, when investors have heterogeneous beliefs about managerial manipulation, the dispersion in belief endogenously gives rise to limited stock market participation. Our model suggests that the increasing stringency of corporate governance and varying composition of investors may have played a role in the contemporaneous run-up of market participation rates in the recent years.

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File URL: http://www.federalreserve.gov/pubs/ifdp/2011/1019/default.htm
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File URL: http://www.federalreserve.gov/pubs/ifdp/2011/1019/ifdp1019.pdf
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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series International Finance Discussion Papers with number 1019.

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Date of creation: 2011
Handle: RePEc:fip:fedgif:1019
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Keywords: Earnings management ; Stocks - Rate of return;

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  1. H. Henry Cao & Tan Wang & Harold H. Zhang, 2005. "Model Uncertainty, Limited Market Participation, and Asset Prices," Review of Financial Studies, Society for Financial Studies, vol. 18(4), pages 1219-1251.
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  14. Allen, Franklin & Gale, Douglas, 1994. "Limited Market Participation and Volatility of Asset Prices," American Economic Review, American Economic Association, vol. 84(4), pages 933-955, September.
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  18. Annette Vissing-Jorgensen, 2002. "Limited Asset Market Participation and the Elasticity of Intertemporal Substitution," Journal of Political Economy, University of Chicago Press, vol. 110(4), pages 825-853, August.
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