Market Reaction to Earnings Management: New Evidence from the Johannesburg Securities Exchange

Abstract

This paper investigates whether investors in an emerging economy setting value book value of equity, earnings and discretionary accruals differently for firms that have managed earnings relative to those who have not. Discretionary accruals are estimated using the conventional modified John’s model Dechow, Sloan, and Sweeny (1995) and the less commonly used but more powerful Ball & Shivakumar’s (2006) model. The distributions of earnings were examined using the kernel density function (Lahr, 2014). To test whether the market values earnings management (EM) and non-earnings management firms (non-EM) firms differently, two value relevance models that are similar to (Lev & Sougiannis, 1999; Ohlson, 1995) and cumulative abnormal stock returns were developed. We find that over four time windows ending 30 days after the date that the directors’ report is signed, investors appear to be able to negatively price discretionary accruals estimated using the Ball and Shivakumar (2006) model, but this reaction is not significantly different between EM and non-EM firms. The paper provides evidence and contributes to the methodological debate on earnings management research in emerging markets.