Stock Market Valuation Driven Earnings Management

This paper investigates whether aggregate stock market valuation impacts management’s decision to manage their earnings. The existing accounting literature assumes that aggregate stock market valuation has a constant impact on this decision. However, we argue that a higher aggregate valuation increases the perceived benefits of earnings management at a time the punishment associated with accrual reversal and the probability of detection are believed to be lower. Using a sample of quarterly data of U.S. firms from 1985 to 2005, we examine whether the one-year lagged aggregate stock market valuation has a significantly positive relationship with aggregate (current) discretionary accruals and (current) discretionary accruals of individual firms. Overall, we find a positive relationship between lagged aggregate stock market valuation and these proxies of earnings management. Empirical results suggest that one standard deviation increase in the aggregate stock market valuation is associated with a significant increase in quarterly earnings per share by several cents.

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Anna Nöteberg

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