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

See all articles by Jeremy Bertomeu

Jeremy Bertomeu

University of California, San Diego (UCSD) - Rady School of Management

Date Written: February 15, 2013

Abstract

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

Bertomeu, Jeremy, On Earnings Manipulation and the Cost of Capital: Does Accounting Matter in the Aggregate? (February 15, 2013). Journal of Accounting Research, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2218515 or http://dx.doi.org/10.2139/ssrn.2218515

Jeremy Bertomeu (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

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