Investors Behavior, Governance and Earnings Management: Under and over Reaction to Information

Abstract

The aim of this paper is to study the relationship between earnings management, governance and investors behavior, since this latter can inform about the nature of earnings management and can be considered as a governance mechanism to reduce accounts manipulations. On the basis of a sample of 700 American firms for the period of 1996-2006, our empirical results show that investors who take short positions, are able to interpret the information detected from the earnings management. The activity of these investors may be considered as an indicator of the quality of the governance structure and the presence and nature of earnings management. The under-reaction of investors to information leads to short-term sale of the shares of poorly governed firms and characterized by an opportunistic earnings management and to invest in firms well-governed and characterized by an informational earnings management therefore an abnormal profit can be realized.