AAA Spark Meeting of Regions

Earnings Predictability or Truthfulness? Which One Investors Care More About

• In Event: Debt Renegotiations, Earnings Predictability and Creditor Rights, Ease of Repossession, and the Cost of Equity Capital

Abstract

I conduct an experiment to examine the effects of earnings predictability (quarterly earnings autocorrelation) and earnings truthfulness (real earnings management, REM) on nonprofessional investors’ decisions. Results show that without the consideration of earnings autocorrelation, investment willingness is much higher in absent REM condition. In the interaction effect, investors’ reactions are primarily affected by earnings autocorrelation, not by REM. The higher autocorrelation estimates, the higher investment willingness. These findings provide implications that investors care more about earnings predictability than truthfulness. Further, I find that high earnings autocorrelation indirectly stimulates investment willingness through the perceived persistent earnings. My paper contributes to financial accounting literature on earnings properties. COVID-19 causes many uncertainties. My study reminds investors of the focus on the truthfulness of reported numbers during special times.

Author

• Shihui Fan, Kent State University