Loss Aversion and the Zero-Earnings Discontinuity

46 Pages Posted: 8 Dec 2019

See all articles by Leonidas Enrique de la Rosa

Leonidas Enrique de la Rosa

Aarhus University - Department of Economics and Business Economics

Nikolaj Kirkeby Niebuhr

Aarhus University - Department of Economics and Business Economics

Date Written: August 7, 2019

Abstract

Prior literature suggests that the zero-earnings discontinuity is caused by earnings management. This makes sense if investors are naíve. We test for the possibility of investor naíveté and find that they are aware of firms performing earnings management around zero reported earnings and that there is no obvious gain of reaching zero reported earnings. We extend a signaling model to include loss-averse investors and we find that earnings management is not only rational, but in equilibrium, it is not possible for investors to deduce the correct value of firms' earnings around the discontinuity. Our model could be applied to other reference points besides zero earnings, such as expected or last year's earnings

Keywords: Discontinuity, Loss Aversion, Reporting, Signaling

JEL Classification: C70, D91, G41, M41

Suggested Citation

de la Rosa, Leonidas Enrique and Niebuhr, Nikolaj Kirkeby, Loss Aversion and the Zero-Earnings Discontinuity (August 7, 2019). Available at SSRN: https://ssrn.com/abstract=3491149 or http://dx.doi.org/10.2139/ssrn.3491149

Leonidas Enrique De la Rosa

Aarhus University - Department of Economics and Business Economics ( email )

Fuglesangs Alle 4
Aarhus, 8210
Denmark

Nikolaj Kirkeby Niebuhr (Contact Author)

Aarhus University - Department of Economics and Business Economics ( email )

Fuglesangs Allé 4
Aarhus V, 8210
Denmark

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
45
Abstract Views
502
PlumX Metrics