The Earnings Game with Behavioral Investors

49 Pages Posted: 4 Mar 2008

See all articles by Thorsten Hens

Thorsten Hens

University of Zurich - Department of Banking and Finance; Norwegian School of Economics and Business Administration (NHH); Swiss Finance Institute

Date Written: March 3, 2008

Abstract

This paper studies how the investors' attitude towards earnings surprises affects the managers' incentives to manipulate earnings in an intertemporal context, where the consensus forecast of the analysts is not exogenously given but determined by the strategic interaction between the analysts and the managers. Our analysis shows that given the asymmetric investors' reaction to earnings surprises, managers have strong incentives to manipulate earnings. In dependence on their time preferences, managers may choose to manipulate the earnings in order to match the consensus forecasts. In this equilibrium, rational investors are systematically fooled. Assuming that managers' preferences are equally distributed in the economy, we also derive conclusions on how the absolute level of manipulation in the economy changes with the investors' preferences, the managers' compensation package and the earnings guidance they may provide to analysts.

Keywords: earnings management, loss aversion, disclosure policy

JEL Classification: G38, G29, M21, C70, M41, M43

Suggested Citation

Hens, Thorsten, The Earnings Game with Behavioral Investors (March 3, 2008). Available at SSRN: https://ssrn.com/abstract=1101505 or http://dx.doi.org/10.2139/ssrn.1101505

Thorsten Hens (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Plattenstrasse 32
Zurich, 8032
Switzerland
+41-44 634 37 06 (Phone)

Norwegian School of Economics and Business Administration (NHH)

Helleveien 30
Bergen, 5045
Norway

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

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