Stock Liquidity and Accruals-based Earnings Management : The Three Views

The literature offers three views on the effect of stock liquidity on accruals-based earnings management. According to the takeover threat view, stock liquidity makes a firm prone to hostile takeovers and thereby spurs its managers to use accruals-based earnings management to move stock price upward and then avoid becoming a takeover target; according to the governance view, stock liquidity amplifies the deterring effect of blockholder intervention and exit on accruals-based earnings management and thereby dampens accruals-based earnings management; according to the information efficiency view, stock liquidity dampens accruals-based earnings management by making it difficult for managers to move stock price using accruals-based earnings management and by making stock price revealing about the value-destroying consequence of accruals-based earnings management. Consistent with the latter two views and inconsistent with the first view, we find that stock liquidity dampens accruals-based earnings management. Importantly, we find support for the mechanisms underlying the information efficiency view and find no support for the mechanisms suggested for the governance view