Competing for Attention: Earnings Management for Record EPS

• In Event: Do Bad Firms Have Bad Accounting?

Abstract

Investors exposed to tremendous financial information tend to underreact to new information due to human cognitive constraints. In such cases, managers have strong incentives to attract investor attention when they have positive news to announce. This paper studies whether managers strategically apply earnings management in the competition for investor attention. With a large sample of U.S. firms over the period 2003-2015, I find that discretionary accruals are significantly higher for high record EPS firm quarters suggesting that managers intentionally manipulate earnings upward to create record EPS. Such earnings management is significantly higher for less visible firms which have a stronger desire for market attention. Also, such earnings management is monitored and mitigated by the existence of nontransient institutional investors. Further evidence shows that investors are indeed more sensitive to high record EPS. Announcement window cumulative abnormal return and abnormal trading volume are both significantly higher for record EPS. This indicates that managers’ earnings management for record EPS is effective in attracting investor attention. Furthermore, such competition for investor attention is less strong during down market periods when investors pay relatively lower level of attention to the whole stock market.

Author

• Rongbing Liu, University of Massachusetts-Boston