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Earnings Management and the Post-Earnings Announcement Drift

54 Pages Posted: 10 Jan 2008 Last revised: 13 Mar 2011

Henock Louis

Pennsylvania State University - Smeal College of Business

Amy X. Sun

University of Houston

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2008

Abstract

There is reliable evidence that managers smooth their reported earnings. If some firms manage earnings downwards (upwards) when they experience large positive (negative) earnings shocks and if investors have cognitive limits or are inattentive, then it is plausible that the post-earnings announcement drift could be related to earnings management. Consistent with this conjecture, we find that firms with large negative (positive) changes in operating cash flows manage their accruals substantially upwards (downwards). Most importantly, we find no evidence of a positive post-earnings announcement drift for those firms with large positive earnings changes that are least likely to have managed earnings downward or a negative post-earnings announcement drift for those firms with large negative earnings changes that are least likely to have managed earnings upward. That is, for these firms, there is no evidence of an underreaction to earnings changes. The underreaction is concentrated largely among those firms that are most likely to have smoothed their reported earnings, although this effect has weakened in recent years as investors started paying more attention to the anomalies and hedge funds were focusing on exploiting them. Finally, consistent with the earnings management hypothesis, we also find that the post-earnings announcement drift is generally associated with discretionary (or abnormal) accruals and not with nondiscretionary accruals. These findings reconcile PEAD with the (abnormal) accrual anomaly.

Keywords: Market anomalies, post-earnings-announcement drift, (abnormal) accrual anomaly, earnings management, earnings smoothing

JEL Classification: G12, G14, M41, M43

Suggested Citation

Louis, Henock and Sun, Amy X., Earnings Management and the Post-Earnings Announcement Drift (January 1, 2008). Available at SSRN: https://ssrn.com/abstract=1010103 or http://dx.doi.org/10.2139/ssrn.1010103

Henock Louis (Contact Author)

Pennsylvania State University - Smeal College of Business ( email )

University Park, PA 16802-3306
United States
814-865-4160 (Phone)
814-863-8393 (Fax)

Amy X. Sun

University of Houston ( email )

Bauer College of Business
334 Melcher Hall, 390H
Houston, TX 77204
United States
7137435682 (Phone)

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