Real Earnings Management and Cost of Capital
50 Pages Posted: 12 Jan 2013 Last revised: 14 Jan 2013
Date Written: 2013
This study investigates whether a firm’s cost of equity capital is influenced by the extent of a firm’s real activities management. Using a large sample of U.S. firms, we find that our proxy for the cost of capital is positively associated with the extent of earnings management through the real activities manipulation after controlling for the effect of the accrual-based earnings management. We also provide evidence suggesting that this positive association stems from managerial opportunism rather than from the measurement errors in our real earnings management proxies. The main findings are robust to a battery of sensitivity tests. Collectively, our results suggest that real earnings management activities exacerbate the information quality of earnings used by outside investors, and thus the market demands a higher risk premium for these activities, which is incremental to the risk premium for the accrual-based earnings management.
Keywords: real earnings management, accrual-based earnings management, cost of capital, earnings quality
JEL Classification: G14, M41, M43
Suggested Citation: Suggested Citation