Abstract
This paper demonstrates the usefulness of earnings management in correcting stock underpricing. We find that underpricing, measured using mutual fund fire sales or the 2003 trading scandal as a shock, increases the likelihood of firms meeting or marginally beating analyst forecasts. Firms beat earnings targets by cutting R&D as well as making income-increasing reporting choices, but lean towards R&D reduction if reporting manipulation becomes costly. While both types of manipulation accelerate price reversal after fire sales, firms cutting R&D underperform those using accruals in the long-run. These results suggest that reporting discretion can sometimes be desirable to avoid real consequences.
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