The Earnings Game with Behavioral Investors
49 Pages Posted: 4 Mar 2008
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: Suggested Citation
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