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Does Earnings Management Affect Firms’ Investment Decisions?

Maureen F. McNichols · Stephen R. Stubben

963 citations0/0 files storedThe Accounting Review

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

ABSTRACT: This paper examines whether firms manipulating their reported financial results make suboptimal investment decisions. We examine fixed asset investments for a large sample of public companies during the 1978–2002 period and document that firms that manipulate their earnings—firms investigated by the SEC for accounting irregularities, firms sued by their shareholders for improper accounting, and firms that restated financial statements—over-invest substantially during the misreporting period. Furthermore, following the misreporting period, these firms no longer over-invest, consistent with corrected information leading to more efficient investment levels. We find similar patterns for firms with high discretionary revenues or accruals. Our findings suggest that earnings management, which is largely viewed as targeting parties external to the firm, can also influence internal decisions.

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References

1969Investigating Causal Relations by Econometric Models and Cross-spectral Methods 1958The Cost of Capital, Corporation Finance and the Theory of Investment 1973Risk, Return, and Equilibrium: Empirical Tests 2008The cost of capital, corporation finance and the theory of investment 1997Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?1995Detecting Earnings Management.1999A Review of the Earnings Management Literature and Its Implications for Standard Setting 1996Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*

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