Investor sentiment and earnings management in Brazil

Abstract

This research analyzes whether there is a temporal association between investor sentiment and earnings management in Brazil. Several studies have investigated the determinants of earnings management, such as factors inside or external to companies and regulatory requirements, but few have considered personal factors, such as investor sentiment in Brazil. With this investigation, it was apparent from the findings that accruals quality is affected by investor sentiment. For participants in the Brazilian capital market, this research reinforces the need for a more careful analysis of the results reported by companies, since managers, in response to investor sentiment, may manage earnings to inflate accounting profit through accruals and influence the market’s ability to price shares correctly. It is evident that accounting choices are much more than just financial decisions and are subject to investor sentiments. The effect of investor sentiment should be considered among the determinants of future earnings management. A sample of non-financial Brazilian companies that traded shares on the Brasil, Bolsa, Balcão (B3) exchange from 2010 to 2016 was used. The investor sentiment index was calculated according to the methodology of Baker and Wurgler (2007). For earnings management, the models of Kang and Sivaramakrishnan (1995), Kothari, Leone, and Wasley (2005), and Dechow, Hutton, Kim, and Sloan (2012) were used. The estimates were carried out through regressions for pooled panel data, fixed, and dynamic effects using the system generalized method of moments (GMM) estimator. Discretionary accruals are positively associated with investor sentiment in the Brazilian capital market, in a similar way to markets with greater informational efficiency and notwithstanding the code-law system. Analyzing low and high sentiment periods separately, the findings suggest that managers increase accruals after high sentiment and reduce them after low sentiment.

Investor sentiment, economic uncertainty, and monetary policy in Brazil,

“…This result is consistent with the theoretical developments (Kurov, 2010;Silvia & Iqbal, 2011;Vuchelen, 2004) and with recent empirical and experimental research (Cohen & Kudryavtsev, 2012;Menkhoff & Rebitzky, 2008;Zhang, 2019). Understanding this relationship is hugely desirable in Brazil, whose stock market is undeniably affected by investor sentiment (Lucchesi et al, 2015;Piccoli et al, 2018;Prates et al, 2019;Santana et al, 2020;Xavier & Machado, 2017;Yoshinaga & Castro, 2012).…”

“…Finally, some evidence indicates that investor sentiment also affects earnings management and, therefore, firm-level decisions. This occurs as accounting choices are much more than financial decisions and are subject to psychological biases (Santana et al, 2020). These characteristics imply the need for a greater understanding of the factors that affect Brazilian investor sentiment.…”

“…In Brazil, the research in this area is still recent and remains in its infancy. The national literature has documented evidence on investor sentiment and its relationship with stock returns (Yoshinaga & Castro, 2012), anomalies (Xavier & Machado, 2017), risk and return (Piccoli et al, 2018), earnings management (Santana et al, 2020), and the disposition effect (Lucchesi et al, 2015;Prates et al, 2019), but it is not yet clear what affects Brazilian investor sentiment. According to Yoshinaga and Castro (2012), more recent studies try to provide more explanations for the influence of sentiment on financial markets.…”

The Effects of Car Wash Operation on the Brazilian Capital Market: The Petrobras Case

“…In itself, this rational action about the non-rationality of the investor, predominantly emotional, may configure and result in biases (Taffler & Tuckett, 2010). Some studies published internationally and nationally have demonstrated the influence of investor sentiment on financial decisions (Baker & Wurgler, 2007;Yoshinaga, 2009) in the formation of overly optimistic or pessimistic accounting profit expectations by analysts and investors and how these profit forecasts affect the relation between investor sentiment and stock returns (Santana, Santos, Carvalho Júnior, & Martinez, 2020).…”

The Relationship between Earnings Management and Equity Market Timing

“…Besides this, managers can change the company's accounting policy to raise the optimism level about its future forecasts, changing investors' perception (Healy & Wahlen, 1999;Paulo, 2007). Studies such as those by Yu, Hagigi, and Stewart (2018), Du (2019), and Santana, Santos, Carvalho Júnior, and Martinez (2020) found a relationship between earnings management and investor perception.…”