The Effect of Real Earnings Management on the Value-Relevance of Accounting Information

This study is aimed at exploring the effect of real earnings management on the value-relevance of accounting information. Following Roychowdhury (2006) and Cohen, Dey, and Lys (2008), this study uses abnormal cash flow from operating, abnormal discretionary expense, and abnormal production cost to proxy real earnings management. This study hypothesizes that real earnings management will hamper earnings persistence and thus reduce the value-relevance of earnings. Concurrently, real earnings management will make investors rely more on equity book value in pricing stock shares when the value-relevance of earnings decreases, and thus enhance the value-relevance of equity book value. Based on the empirical results via price-earnings-book value model and sample firms during 1990-2008, the hypotheses of this study gain solid support. These results are robust to control for liability to assets ratio, negative earnings, return on equity, usage of other real earnings, and to conduct unbalanced panel-data test.