On Earnings Manipulation and the Cost of Capital: Does Accounting Matter in the Aggregate?
Journal of Accounting Research, Forthcoming
23 Pages Posted: 16 Feb 2013 Last revised: 21 Feb 2013
Date Written: February 15, 2013
This article develops further results on earnings management and the cost of capital, which complement Strobl (Journal of Accounting Research, forth.). Within a simplified version of the model, I illustrate the existing linkage between earning management activities and firms' cost of capital, even if the individual fraud risk is diversifiable. I identify plausible conditions under which the cost of capital will increase with more earnings management and show that the level of managerial ownership and enforcement are important testable determinants of this association. Lastly, I argue that, in the absence of an observable aggregate wealth portfolio, whether accounting quality is informative on firms' beta or a separate risk factor are observationally equivalent propositions. I then show that an aggregate accounting quality measure would provide information about expected returns.
Keywords: cost of capital, earnings management, accounting, risk, return
JEL Classification: G12, M4
Suggested Citation: Suggested Citation