Managerial Response to Non-Fundamental Price Shocks

• In Event: Earnings Management I

Abstract

We find that managers significantly alter their behavior in response to non-fundamental declines in price. In particular, after an exogenous, non-fundamental price drop, managers increase their disclosure quality,
and shift accrual earnings management to real earnings management. Moreover, managers with high equity incentives engage more in real earnings management, while managers with high litigation risk tend to increase their disclosure quality and decrease accrual earnings management. We confirm that the net effect of earnings management, in response to non-fundamental price shocks, results in firms more frequently reporting "suspicious" earnings. Firms that experience large non-fundamental price declines are more likely, on average, to meet or beat analysts’ earnings expectations by 1 or 2 cents in our sample. Our findings suggest that non-fundamental price variation is an important driver of firm disclosure policy, and earnings management.

Authors

• John C. Heater, Yale University

• Ben Matthies, Yale School of Management

• Yukun Liu, Yale University