The economic importance of earnings manipulation

Sammanfattning: Although studies have analyzed the effects of earnings manipulation on stock prices and the cost of capital, the measurements have been prone to error and little emphasis has been put on the fundamental effects. Therefore, the main purpose of this study has been to describe the economic importance of earnings manipulation. Further, a second purpose was to describe the economic consequence of changes in bankruptcy probability due to earnings manipulation. To answer the purposes, 52 firms subject to AAER's by the SEC have been investigated. These firms had filed restated annual reports due to earnings manipulation during the years 1996-2012. Using accounting based bankruptcy models and a standardized risk adjusted RIV model, we conclude that the effects can be more severe than stated in previous studies. The results indicate that the magnitude of the value manipulation range from 0 - 100 % of the fundamental value. Further, the effect of earnings manipulation on the estimated bankruptcy probability is concluded to be of practical significance, with a deflation up to 10,02 percentage units. Regarding the second purpose, it was concluded that the inflation of fundamental value is not due to the changes in the bankruptcy probability induced by earnings manipulation. However, it seems like the firms experiencing a higher bankruptcy probability are the same firms inflating their fundamental value and deflating their bankruptcy probability the most. The findings in this study indicate both practical and academic implications for bankruptcy probability assessment, earnings manipulation and capital market research.