Do Verified Earnings Reports Increase Investment?

45 Pages Posted: 2 Jun 2014 Last revised: 10 Aug 2020

See all articles by Radhika Lunawat

Radhika Lunawat

University of California, Irvine - Accounting Area

Gregory B. Waymire

Emory University - Department of Accounting

Baohua Xin

University of Toronto - Rotman School of Management

Date Written: August 9, 2020

Abstract

A common view is that verified earnings reports encourage investment through improved transparency. We lack direct evidence on this foundational proposition because researchers cannot observe counterfactuals where a manager either: (1) must remain silent about performance or (2) can make any statement about performance she desires, even a bald-faced lie. We experimentally manipulate whether a manager can provide information to an investor either by voluntarily disclosing a verified earnings report, communicating freely via unverifiable cheap talk, or both. Our experiment involves repeated interactions between an uninformed investor with funds that, if invested, generate uncertain gains, and a trustee-manager who observes and then divides gains after they are realized. We hypothesize and find that: (1) the provision of a verified earnings report leads to higher investment compared to a world where reporting is not possible, and (2) the provision of a verified earnings report leads to more accurate cheap talk communication than when earnings reports are unavailable. Contrary to our prediction, we find that investment when both earnings reports and cheap talk are possible is statistically indistinguishable from investment when only cheap talk communication is available. Further tests reveal that a lack of verified earnings reports leads managers to sustain a partner’s investment by providing high returns to the investor while also limiting (but not completely eliminating) deceptive communication and profit-taking. Our main conclusion is that verified earnings reports promote investment on a stand-alone basis by improving transparency, but the effect of greater transparency from earnings reports on investment is more nuanced when earnings reports can influence the disclosure of unverifiable information. The main implication of our evidence is that the greater transparency of management behavior with verified earnings reports is not unambiguously positive since making behavior more transparent can lead managers to change their behavior.

Keywords: Earnings Reports, Cheap Talk, Information Verification, Multi-Period Investment Game

JEL Classification: C72, C91, D82, M41

Suggested Citation

Lunawat, Radhika and Waymire, Gregory B. and Xin, Baohua, Do Verified Earnings Reports Increase Investment? (August 9, 2020). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2444129 or http://dx.doi.org/10.2139/ssrn.2444129

Radhika Lunawat

University of California, Irvine - Accounting Area ( email )

Irvine, CA 92697-3125
United States

Gregory B. Waymire (Contact Author)

Emory University - Department of Accounting ( email )

Goizueta Business School
1300 Clifton Road
Atlanta, GA 30322
United States
404-727-6589 (Phone)
404-727-6313 (Fax)

Baohua Xin

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

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