Investment Company Reporting: Earnings Management Implications of Closed-End Fund Restricted Security Investments

Abstract:     
This study investigates whether valuation of restricted securities by closed-end fund managers is driven by incentives to (1) maximize current period compensation; (2) minimize the long-run probability that the fund manager does not achieve benchmark returns; or (3) smooth fund returns. Valuation discretion arises due to the absence of exogenously determined market prices for these securities.Empirical examination of 363 annual reports and supplementary portfolio information indicates that closed- end fund managers use accounting discretion to decrease fund returns more when fund performance relative to benchmark returns is extreme. The evidence is not consistent with fund managers using accounting discretion to maximize current period compensation or to smooth fund returns. This study has implications for policy discussions relating to fund managers' discretion in valuing securities in their portfolios, contract design issues, and the possibility of additional and separate disclosures of restricted and non- restricted components of fund assets and earnings.

JEL Classification: M41, M43, J33

working papers series