Earnings Quality and Market Performance in LATAM Corporations: A Combined Agency and Cognitive Approach to Investors’ Perceptions of Managerial Information

Abstract

This chapter studies the impact of financial reporting quality on firms' market performance in a sample of LATAM corporations. We infer that, especially in contexts of high information asymmetry, investors are not able to effectively discern the quality of the information they are provided with and can therefore be misled in their investment decisions by managerial opportunism. Our theoretical framework is built upon a combined agency theory and cognitive approach. We thereby seek to provide a valuable method to better understand how investors could be making suboptimal choices as a consequence of managers' opportunistic behaviour. Empirically, we use the Generalized Method of Moments (GMM) model, hypothesizing that a positive relationship should be observed between the opportunistic manipulation of earnings (that is, the misuse of accounting accruals) and the firm's market performance (that is, the consequential behaviour of investors). Through this 'pioneering' methodology, applied to the relatively under-researched LATAM region, we find that: (1) Financial data are identifiably and consistently manipulated through discretionary accruals in these countries. (2) As manipulation increases, markets do tend to appear more attractive to investors. (3) The elasticity of the market reaction to this manipulation is higher in what we term 'opaque' countries.

Real earnings management and corporate governance: a study of Latin America

“…The p-values are reported in the last column, and through these we strongly reject the null hypothesis that mean values are equal to zero, meaning that the Latin American companies included in our sample overstate their financial statements through real activities manipulation, on average. This finding is like those reported recently by Saona, et al (2017) concerning accrual-based earnings management measures in Latin American firms. Recall that we are interested in the extent of the financial reporting manipulation, not in the direction.…”

“…This fact minimises the informative content of the future earnings, misleading investors to make less informed investing decisions. As stated by Saona et al (2017), in the institutional environments of high information asymmetry, such as the Latin American one, investors are not able to effectively discern the quality of the information they are provided with and can therefore be misled in their investment decisions by managerial opportunism. According to the behavioural finance approach, the perception of market participants is likely to be biased because of the lack of transparency in pricing and poor quality of financial reporting, which encourage managers to overstate financial information for higher market valuation.…”

“…This article analyses the effect of the ownership structure features and the institutional characteristics on real activities manipulation, also known as real earnings management. Earnings are the baseline number used by shareholders to decide whether to invest in a firm's stock (Dechow, Ge, & Schrand, 2010;Saona et al, 2017). At the same time, earnings are the criteria by which managers' performance is evaluated and compensation is paid (Shayan-Nia et al, 2017).…”

The impact of corporate reporting readability on informational efficiency

“…These studies primarily focus on the numerical part of corporate reporting, such as different types of accruals (e.g. Saona et al , 2017; Perotti and Windisch, 2017) and earnings (Martineau, 2018), ignoring the textual-linguistic aspect. However, the non-numerical part of the corporate report, i.e., the textual-linguistic part, represents the great majority of the corporate report and therefore, the clarity of this part is crucial to fully convey information (Lo et al , 2017).…”

Pengaruh Free Cash Flow, Profitability, dan Audit Quality Terhadap Earnings Management Perusahaan Manufaktur di Indonesia

“…Manajemen laba akan memperlihatkan seberapa besar return perusahaan yang dikelola. Pendapatan atau return ini merupakan angka dasar yang digunakan pihak investor dalam hal memutuskan untuk melanjutkan investasinya atau tidak (Saona et al, 2017). Pada saat yang sama, pendapatan adalah kriteria yang digunakan oleh manajer untuk melakukan evaluasi atas kompensasi dibayarkan (Mojtaba Shayan Nia, 2017).…”