Earnings Management and Managerial Honesty: The Investors’ Perspectives

University of Zurich - Department of Banking and Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Swiss Finance Institute

There are 2 versions of this paper

Date Written: July 25, 2022

Abstract

This paper studies how investors infer CEO commitment to honesty from earnings management and how these perceptions – in conjunction with investors’ own social and moral preferences – shape their investment choices. We conduct two laboratory experiments simulating investment choices. Our results show that participants perceive a CEO to be more committed to honesty when they infer that the CEO engaged less in earnings management. For investment decisions, a one standard deviation increase in a CEO's perceived commitment to honesty compared to another CEO reduces the relevance of differences in the CEOs’ claimed future returns by 40%. This effect is most prominent among investors with a proself value orientation. To prosocial investors, their own honesty values and those attributed to the CEO matter directly, while returns only play a secondary role. Overall, our results suggest that moral motives are not a niche concern for norm-constrained investors, but instead matter to different categories of investors for distinct reasons.

Keywords: Earnings management, honesty, investor preferences, investor segmentation, protected values

JEL Classification: M41, G41, G11

Suggested Citation: Suggested Citation

Gibson, Rajna and Sohn, Matthias and Tanner, Carmen and Wagner, Alexander F., Earnings Management and Managerial Honesty: The Investors’ Perspectives (July 25, 2022). Swiss Finance Institute Research Paper No. 17-03, European Corporate Governance Institute (ECGI) - Finance Working Paper No. 516/2017, Available at SSRN: https://ssrn.com/abstract=2912795 or http://dx.doi.org/10.2139/ssrn.2912795