Asset Returns with Earnings Management

59 Pages Posted: 12 Mar 2010

See all articles by Bo Sun

Bo Sun

University of Virginia Darden School of Business

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Date Written: March 11, 2010

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: E44, D82, D83, G12

Suggested Citation

Sun, Bo, Asset Returns with Earnings Management (March 11, 2010). Available at SSRN: https://ssrn.com/abstract=1569060 or http://dx.doi.org/10.2139/ssrn.1569060

Bo Sun (Contact Author)

University of Virginia Darden School of Business ( email )

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