Earnings Manipulation and the Cost of Capital

31 Pages Posted: 23 Mar 2009

See all articles by Günter Strobl

Günter Strobl

University of Vienna - Department of Finance

Date Written: March 18, 2009

Abstract

The widespread use of accounting information by investors and financial analysts to help value stocks creates an incentive for managers to manipulate earnings in an attempt to influence short-term stock price performance. This paper examines the role of earnings management in affecting a firm's cost of capital. Using an agency model with multiple firms whose cash flows are correlated, we demonstrate that the extent of earnings manipulation varies across the business cycle. Managers are more inclined to engage in manipulation during periods of economic expansion. Because of this dependence on the state of the economy, earnings manipulation influences a firm's cost of capital despite the forces of diversification. In particular, we find that manipulation reduces the correlation between the firms' cash flows and thus lowers the risk premium required by investors.

Keywords: Earnings management, Information manipulation, Cost of capital

JEL Classification: G12, M41

Suggested Citation

Strobl, Günter, Earnings Manipulation and the Cost of Capital (March 18, 2009). Available at SSRN: https://ssrn.com/abstract=1364282 or http://dx.doi.org/10.2139/ssrn.1364282

Günter Strobl (Contact Author)

University of Vienna - Department of Finance ( email )

Oskar-Morgenstern-Platz 1
Vienna, 1090
Austria

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