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
Date Written: March 23, 2020
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: Suggested Citation