Market Rewards to Patterns on Increasing Earnings: Do Cash Flow Patters, Accruals Manipulation and Real Activities Manipulation Matter?

Abstract

This study explores whether firms have differential price-earnings multiples associated with their means of achieving a sequential pattern of increasing positive earnings. Our main findings show that market participants assign higher price-earnings multiples to firms when their pattern of increasing earnings is supported by the same pattern of increasing cash flows. Market participants assign lower price-earnings multiples to firms suspected of having engaged in accrual-based earnings management, sales manipulation, and overproduction to achieve the earnings pattern. We find, however, that market participants do not penalize firms suspected of having achieved the earnings pattern through the opportunistic reduction of discretionary expenses.