The Role of Earnings Management in Equity Valuation

Abstract

The intrinsic value of a firm's equity is determined by the present value of future payoffs to equity-holders. Thus, to estimate equity value, one needs to identify and process a series of information that is relevant to the present value of expected future payoffs. Among the valuerelevant information, earnings pertain to a summary measure of firm performance, and thus play a key role in the equity valuation. Nevertheless, it is not uncommon in practice that firm managers either intentionally or unintentionally misreport earnings, making valuation challenging for outsiders. This chapter aims to explore the role earnings management plays in equity valuation, and how market participants may detect and adjust for misreported earnings, if any, in their forecasts and valuation for a firm. The chapter is organized to comprise the following sections: (i) varied managerial incentives for earnings management; (ii) various tactics of earnings management via accruals manipulation; (iii) various tactics of earnings management via real activities manipulation; (iv) consequences and determinants of earnings management; (v) trade-off between accruals manipulation and real activities manipulation to manage earnings; (vi) how to discern and measure earnings management; (vii) introduction of various equity-valuation models; (viii) how to adjust for the effects of accruals-based and real earnings management in equity valuation.

Labor unionization and real earnings management: Evidence from labor elections

“…REM2 is as defined by [ 9 ]. REM1_R is also defined by [ 14 ] with the abnormal operating cash flow measure calculated as per [ 45 ]. Panel B shows the summary statistics of firm fundamentals.…”

“…Panels C-D of Table 3 report the results for alternate REM measures. Columns (1)-(3) of Panel C show results for [ 45 ]’s REM measure ( ΔREM1_R ), while columns (4)-(6) report the results when the REM measure in the following year is used as DVs ( REM1 t+ 1 ). Panel D reports the results when [ 3 ]’s REM measure and its value in the following year ( ΔREM1 and REM1 t+1 ) are used as DVs.…”

“…Besides, we test robustness using an alternate measure of abnormal operating cash flow ( OANCF_R ) defined by [ 45 ]: …”