Capital Market Efficiency and Managerial Discretion over Accounting Choices: Evidence from the Relation between Stock Liquidity and Accrual-based Earnings Management

59 Pages Posted: 16 Apr 2020

See all articles by Zhuo (June) Cheng

Zhuo (June) Cheng

Hong Kong Polytechnic University - School of Accounting and Finance

Jing Fang

Hong Kong Polytechnic University

Date Written: March 23, 2020

Abstract

We reason that stock liquidity, due to its enhancing effect on price efficiency, dampens accrual-based earnings management (AEM) by making it difficult for managers to use AEM to move stock price and by making stock price revealing about the value-destroying consequence of AEM. Consistent with our reasoning, we document three major findings:

(a) stock liquidity has a causal dampening effect on AEM;

(b) the higher stock liquidity, the weaker the relation between discretionary accruals and mis-valuation and the more informative stock price about future earnings; and

(c) the greater the value-destroying consequence of AEM, the stronger the dampening effect of stock liquidity on AEM.

Our findings affirm the view that when facing a more efficient stock market managers exert less discretion over accounting choices.

Keywords: Stock Liquidity, Efficiency, Accounting Choices, Accruals, Earnings Management

JEL Classification: G14, G40, M40, M41

Suggested Citation

Cheng, Zhuo (June) and Fang, Jing, Capital Market Efficiency and Managerial Discretion over Accounting Choices: Evidence from the Relation between Stock Liquidity and Accrual-based Earnings Management (March 23, 2020). Available at SSRN: https://ssrn.com/abstract=3559135 or http://dx.doi.org/10.2139/ssrn.3559135

Zhuo (June) Cheng (Contact Author)

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Jing Fang

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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