Does Stock Market Liquidity Help Deter Earnings Management? Evidence from the SEC Tick Size Pilot Test

45 Pages Posted: 18 Aug 2016 Last revised: 6 Jul 2019

See all articles by Dan Li

Dan Li

The University of Hong Kong - School of Economics and Finance

Ying Xia

Monash University - Monash Business School

Date Written: July 3, 2019

Abstract

In this paper, we study whether stock market liquidity has a causal effect on earnings management using a sample of U.S. public firms. We introduce a new and cleaner identification of a liquidity shock—the 2016 Tick Size Pilot Program—to show that firms with less liquid stocks are more likely to meet or marginally beat analyst earnings forecasts, and engage in real earnings management. We provide direct evidence that stock liquidity helps to deter earnings management via enhancing governance by long-term institutional investors through trading and direct intervention, and via facilitating short selling to discipline managers. The effect is stronger in firms that do not pay dividends.

Keywords: Stock Liquidity; Real Earnings Management; Meet Analyst forecast; Institutional Investors; Short Seller

JEL Classification: G14; G23; M41

Suggested Citation

Li, Dan and Xia, Ying, Does Stock Market Liquidity Help Deter Earnings Management? Evidence from the SEC Tick Size Pilot Test (July 3, 2019). 29th Australasian Finance and Banking Conference 2016. Available at SSRN: https://ssrn.com/abstract=2825789 or http://dx.doi.org/10.2139/ssrn.2825789

Dan Li

The University of Hong Kong - School of Economics and Finance ( email )

Shenzhen
China

Ying Xia (Contact Author)

Monash University - Monash Business School ( email )

900 Dandenong Road
Caulfield Campus
Melbourne, Victoria 3145
Australia

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