Asset Returns with Earnings Management

67 Pages Posted: 24 Sep 2009 Last revised: 5 Oct 2009

See all articles by Bo Sun

Bo Sun

University of Virginia Darden School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: April 2009

Abstract

The paper investigates stock return dynamics in an environment where executives have an incentive to maximize their compensation by artificially inflating earnings. A principal-agent model with financial reporting and managerial effort is embedded in a Lucas asset-pricing model with periodic revelations of the firm's underlying profitability. The return process generated from the model is consistent with a range of financial anomalies observed in the return data: volatility clustering, asymmetric volatility, and increased idiosyncratic volatility. The calibration results further indicate that earnings management by individual firms does not only deliver the observed features in their own stocks, but can also be strong enough to generate market-wide patterns.

Keywords: Earnings management, Stock returns, Financial anomalies, Volatility clustering, GARCH, Optimal contract

JEL Classification: D82, D83, G12, G14

Suggested Citation

Sun, Bo, Asset Returns with Earnings Management (April 2009). Available at SSRN: https://ssrn.com/abstract=1477548 or http://dx.doi.org/10.2139/ssrn.1477548

Bo Sun (Contact Author)

University of Virginia Darden School of Business ( email )

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