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Prospect Theory and Earnings Manipulation: Examination of the Non-Uniform Relationship between Earnings Manipulation and Stock Returns Using Quantile Regression

Leon Li () and Nen-Chen Richard Hwang ()
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Leon Li: University of Waikato,
Nen-Chen Richard Hwang: California State University, San Marcos

Working Papers in Economics from University of Waikato

Abstract: Using the prospect theory as a research framework, this paper makes contributions by demonstrating that managerial risk preference and stock return may influence a firm’s earnings manipulation behavior. Specifically, this study argues that corporate executives may develop risk-averting (risk-seeking) attitudes because of high and positive (low and negative) stock returns. Under this scenario, managers may decide to actively manage the reported earnings in order to preserve gain (gamble on loss) on stock returns. On the other hand, firm executives may not actively manipulate their reported incomes when experiencing average and close-to-zero stock returns. Using quantile regression method to examine the relation between earnings manipulation and stock returns, this study finds that there is a significantly positive (negative) relation between earnings manipulation and stock returns at the high (low) stock returns quantiles. As predicated, such relation is not significant at the middle range of stock returns. To ensure the findings reported in this study are robust, we conduct several tests. In conclusion, we offer policy implications to regulators.

Keywords: prospect theory; quantile regression; earnings manipulation; stock return; discretionary accruals (search for similar items in EconPapers)
JEL-codes: G12 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cbe, nep-rmg and nep-upt
Date: 2017-10-27
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