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

This study investigates whether opportunistic earnings management affects the value relevance of net income and book value in determining stock price. We document a decrease in the value relevance of earnings in the year of an equity offering for a group of firms that exhibit ex post evidence of earnings management. This decrease is greater for the discretionary component of earnings than for the non-discretionary component. We also find that book values play a more important role in determining stock price when earnings management is present. Our results are robust to model specification and the type of offering but are sensitive to firms' disclosure activity prior to the offering. Overall, the results suggest that investors are able to recognize and adjust for the effects of earnings management when setting stock prices