The Comparative Future Cost of Earnings Management between Accrual-Based and Real Activity Earnings Management: Evidence from Stock Price Crash Risk

It has been well documented in previous research that both accrual-based earnings management(hereafter “AM”) and real activity earnings management (hereafter “RAM”) have a negative effect on future firm value. However, there is little evidence to show which type of earnings management incurs more costs. This study fills such a gap by comparing the costs of both AM and RAM from the perspective of stock price crash risk. Using portfolio approach suggested by Dechow and Dichev(2002), the study finds that both AM and RAM are positively associated with stock price crash risk. More importantly, it further finds that AM more increases stock price crash risk than RAM. In subsequent analyses, this study also finds that RAM based on abnormal production is not associated with stock price crash risk. The result supports Gunny(2010)'s finding that earnings management via RAM based on abnormal production does not reflect managerial opportunism, but is more likely to reflect decisions aimed at improving future performance.