Meeting-or-Beating, Earnings Management, and Investor Sensitivity after the Scandals

Abstract

SYNOPSIS We contribute to the literature investigating the market reaction to firms' small positive earnings surprises following the large accounting scandals in the early 2000s. While prior studies provide evidence that the market no longer rewards firms for meeting-or-beating (MBE) in the post-scandal period, their efforts to address the rationality of the market response invite additional analysis. We demonstrate that the change in the market reaction to MBE is consistent with temporary over-skepticism. Specifically, we show that the market does not differentiate between MBE achieved operationally versus through earnings management, despite previously documented differences in future performance. We explore the relation between MBE, earnings management, and future performance in the post-scandal period and find evidence of mispricing consistent with the market underreacting to small positive earnings surprises earned by firms that do not appear to have manipulated earnings to MBE. Our study provides evidence of a potential market anomaly, which should be of interest to financial managers, researchers, and investors, and speaks to capital market regulation. Data Availability: Data are available from sources identified in the paper.