Real versus Accrual-based Earnings Management and Implied Cost of Equity Capital

Research output: Conference Papers (RGC: 31A, 31B, 32, 33)32_Refereed conference paper (no ISBN/ISSN)peer-review

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Original languageEnglish
Publication statusPublished - 26 May 2011

Conference

Title2011 Annual Conference of Canadian Academic Accounting Association (CAAA)
PlaceCanada
CityToronto
Period26 - 29 May 2011

Abstract

This study investigates whether and how a firm’s cost of equity capital is influenced by the extent of a firm’s real earnings management (REM). Using a large sample of firms over the 22-year period 1987-2008, we find that our implied cost of equity estimates are positively associated with both the extent of REM and the extent of accrual-based earnings management (AEM), but the positive association is stronger for REM than for AEM. We provide evidence suggesting that outside investors take into account the impact of the Sarbanes-Oxley Act (SOX) on the relative costs and benefits of REM and AEM and factor it into their cost of equity estimates when making investment decisions. Collectively, our results suggest that while both REM and AEM exacerbate the quality of earnings used by outside investors, REM does so to a greater extent than AEM, and thus the market demands a higher risk premium for REM activities than for AEM activities, especially in the pre-SOX period.

Citation Format(s)

Real versus Accrual-based Earnings Management and Implied Cost of Equity Capital. / KIM, Jeong Bon; Sohn, Byungcherl Charlie.

2011. Paper presented at 2011 Annual Conference of Canadian Academic Accounting Association (CAAA), Toronto, Canada.

Research output: Conference Papers (RGC: 31A, 31B, 32, 33)32_Refereed conference paper (no ISBN/ISSN)peer-review