Differential impact of earnings management on the accrual anomaly

Abstract

The purpose of the study is to investigate the pricing impact of positive and negative accrual-based earnings management on stock returns. The study considers the moderating role of different cross-sectional effects, namely market effect, size effect, value effect, and momentum effect while examining the association between earnings management and stock return. The pricing impact is examined through univariate, bivariate portfolio methodology, and Fama–MacBeth cross-sectional regression. Based on a sample of 3085 Bombay Stock Exchange-listed stocks, results exhibit that investors perceive positive and negative earnings management differently. It has been found that investors demand a higher premium for stocks with negative earnings management, whereas investors hold stocks with positive earnings management at a lower rate of return. These findings are robust after controlling for cross-sectional effects. The study is among the pioneering attempts to examine the pricing impact of accrual earnings management by taking into account the direction (positive and negative earnings management) as well as the endogeneity nature of earnings management.