Abstract
The objective of this research is to investigate whether earnings management incentives influence the pricing of discretionary accruals. Specifically, we verify if growth opportunity, leverage, free cash flow, insider trading and financial distress are useful to investors to discriminate between opportunistic and informative earnings management.
 
 Using a sample of 486 American firms for the period 2002-2010, we find that discretionary accruals are positively related to stock returns. This relation is more intensive in high growth firms and high levered firms. Indeed, these firms use more informative earnings management to communicate future prospects and good financial situation to external investors. However, discretionary accruals are negatively priced by investors in distressed firms. These firms have a greater incentive to manage earnings opportunistically to hide any financial problem. Likewise, we detect a negative relationship between discretionary accruals and stock returns in firms with excessive free cash flow revealing the opportunistic perspective of earnings management. Finally, we demonstrate that investors award positive (negative) value to discretionary accruals in case of insider buying (selling).
Highlights
The affluent use of financial information by investors and financial analysts to assess firm shares stimulates managers to manipulate earnings and influence market price and returns
Earnings management is possible through discretionary accruals since Generally Accepted Accounting Principles (GAAP) offer to managers the possibility to exercise their discretion over accounting accruals and manage earnings upward or downward according to their objectives
We argue that investors discriminate between opportunistic and informative earnings management and price discretionary accruals differently according to earnings management incentives
Summary
The affluent use of financial information by investors and financial analysts to assess firm shares stimulates managers to manipulate earnings and influence market price and returns. It is interesting to investigate how the stock market reacts to earnings management. Earnings management is possible through discretionary accruals since Generally Accepted Accounting Principles (GAAP) offer to managers the possibility to exercise their discretion over accounting accruals and manage earnings upward or downward according to their objectives. Prior literature has widely investigated the association between earnings management through discretionary accruals and stock returns. Several studies (Balsam, Bartov, & Marquardt, 2002; Siregar & Utama, 2008) approve the opportunistic view of earnings management providing that managers use discretion only for their own profits rather than for the benefits of the stakeholders. Discretionary accruals are negatively priced by an efficient market
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