Overvalued equity, benchmark beating and unexpected accruals

Authors


  • We acknowledge helpful comments from an anonymous referee, the editor (Steven Cahan) and Neil Fargher. We thank participants at the Journal of Contemporary Accounting and Economics Annual Conference, the European Accounting Association Annual Conference, the Accounting and Finance Association of Australia and New Zealand Annual Conference and workshop participants at the Australian National University for their comments. We also thank Elizabeth Carson for providing us with audit firm data.

Abstract

We investigate the extent to which the overvaluation hypothesis provides incentives for managers to beat earnings benchmarks, and whether this benchmark beating can be reliably interpreted as evidence of earnings management. We carefully identify firms immediately above earnings benchmarks that have a priori, overvaluation-based incentives to achieve the benchmark. We therefore focus on benchmark-beating observations where manipulation is most likely, providing a more powerful test of the existence of opportunistic financial reporting. Consistent with overvaluation-related incentives encouraging earnings management, we find that overvalued firms that just exceed levels-related earnings benchmarks have higher unexpected accruals than firms with less extreme valuations.

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