[An auditor's reputation lends credibility to the earnings report that he audits. An unresolved issue is whether auditor size is correlated with auditor quality, where a high-quality auditor is defined as one who brings about more credible earnings reports. According to basic intuition and a modified Holthausen-Verrecchia (1988) model, investors' response to an earnings surprise will depend on the perceived credibility of the earnings report. In this study, we examine whether the earnings response coefficient (ERC) differs between Big Eight (B8) and non-Big Eight (NB8) audited firms. This provides a test of the joint hypotheses that auditor size is a proxy for auditor credibility and of the modified H-V model. Consistent with the joint hypotheses, we find that the ERCs of Big Eight clients are statistically significantly higher than for non-Big Eight clients. The result obtains in both a matched sample of firms paired according to industry membership, and a switch sample of firms grouped according to shifts from and to B8 and NB8 auditors. Furthermore, the result is robust with respect to the inclusion of other explanatory factors for ERC that have been suggested by previous studies: growth and persistence, risk, firm size, and predisclosure information environment.]

An auditor's reputation lends credibility to the earnings report that he audits. An unresolved issue is whether auditor size is correlated with auditor quality, where a high-quality auditor is defined as one who brings about more credible earnings reports. According to basic intuition and a modified Holthausen-Verrecchia (1988) model, investors' response to an earnings surprise will depend on the perceived credibility of the earnings report. In this study, we examine whether the earnings response coefficient (ERC) differs between Big Eight (B8) and non-Big Eight (NB8) audited firms. This provides a test of the joint hypotheses that auditor size is a proxy for auditor credibility and of the modified H-V model. Consistent with the joint hypotheses, we find that the ERCs of Big Eight clients are statistically significantly higher than for non-Big Eight clients. The result obtains in both a matched sample of firms paired according to industry membership, and a switch sample of firms grouped according to shifts from and to B8 and NB8 auditors. Furthermore, the result is robust with respect to the inclusion of other explanatory factors for ERG that have been suggested by previous studies: growth and persistence, risk, firm size, and predisclosure information environment.

Ex post trimming of extreme returns observations that are not data errors causes spurious inferences in tests of market efficiency and behavioral explanations for anomalies. Trimming causes a downward truncation bias in estimated mean returns that is stronger in ex ante subsamples with more loss firms and in which return distributions are more right-skewed. There is an asymmetric U-shaped relation between return right-skewness and loss frequency across deciles of negative return predictors (Accruals, ΔNOA, and NOA), and a downward sloping relationship for positive return predictors (CFO and FCF). Consequently, a least-trimmed square (LTS) 1 percent deletion of returns induces a spurious inverted-U-shaped relation between returns and negative predictors, and an exaggerated positive relation for positive predictors. Thus, the resulting trimmed relations do not reject behavioral explanations for these anomalies. Trimming also induces a spurious loss anomaly. These findings highlight that in return prediction studies, observations should not be deleted based upon the values of the dependent variable, only based upon clearly identified data errors.

We find evidence that investors misprice information contained in book-tax differences (BTDs), measured as the ratio of taxable income to book income, TI/BI. Low TI/BI predicts worse earnings growth and abnormal stock returns than high TI/BI. We find that short sellers and insiders arbitrage BTD mispricing, but the arbitrage is imperfect because of constraints on short selling and insider trading. Under SFAS No. 109 the predictability is stronger for TEMP/BI, the temporary component of TI/BI, which reflects greater managerial discretion. The results are incremental to a large set of known accruals-based anomaly predictors. We suggest that a sunshine policy of disclosing a reconciliation of book and taxable incomes can reduce mispricing of BTDs and improve capital market resource allocation. Data Availability: Data are obtained from the public sources as indicated in the text.

Limited attention theory predicts that higher salience of earnings news implies a stronger immediate market reaction to earnings news and a weaker post-earnings announcement drift (PEAD) or reversal (PEAR). Using a new measure, SALIENCE, defined as the number of quantitative items in an earnings press release headline, we find strong evidence consistent with salience effects. Higher SALIENCE is associated with stronger announcement reaction and subsequent PEAR. Managers are more likely to choose higher SALIENCE before selling shares in the post-announcement period and when earnings are high, but less persistent, and to choose lower SALIENCE before stock option grants. The results are robust to using residual salience and an extended set of control variables. The findings are consistent with managers opportunistically headlining positive financial information in the earnings press release to incite over-optimism in investors with limited attention.

We investigate whether and when firms manage the tone of words in earnings press releases, and how investors react to tone management. We estimate abnormal positive tone, ABTONE, as a measure of tone management from residuals of a tone model that controls for firm quantitative fundamentals such as performance, risk, and complexity. We find that ABTONE predicts negative future earnings and cash flows, is positively associated with upward perception management events, such as, just meeting/beating thresholds, future earnings restatements, SEO, and M&A, and is negatively associated with a downward perception management event, stock option grants. ABTONE has a positive stock return effect at the earnings announcement and a delayed negative reaction in the one and two quarters afterward. Balance sheet constrained firms and older firms are more likely to employ tone management over accruals management. Overall, the evidence is consistent with managers using strategic tone management to mislead investors about firm fundamentals.

We test whether earnings management spreads between firms via shared directors. We find that a firm is more likely to manage earnings when it shares a common director with a firm that is currently managing earnings and is less likely to manage earnings when it shares a common director with a non-manipulator. Earnings management contagion is stronger when the shared director has a leadership or accounting-relevant position (e.g., audit committee chair or member) on its board or the contagious firm's board. Irregularity contagion is stronger than error contagion. The board contagion effect is robust to controlling for endogenous matching of firms with directors, fixed firm/director effects, incidence of M&A, industry, and contagion via a common auditor or geographical proximity. These findings support the view that board monitoring plays a key role in the contagion and quality of firms' financial reports. JEL Classifications: M40; M41; M49; G34; G39; D83. Data Availability: Data are available from sources identified in the text.

We study how public firm misvaluation affects private peer firm investments. An economic competition hypothesis predicts a negative relation because misvaluation-induced new investment by public firms crowds out investment by private peers that share common input or output markets. An alternative shared sentiment hypothesis predicts a positive relation because private firm stakeholders share in the sentiment associated with misvaluation in public markets. Misvaluation is proxied using both the price-to-fundamental ratio and an exogenous instrument obtained from mutual fund flows. The evidence is consistent with the shared sentiment hypothesis, and robust to alternative treatments for growth opportunities. Private firms finance misvaluation-induced investment primarily internally or externally with debt, not equity. Finally, misvaluation-induced investment increases future return on investment for private firms, in contrast with public firms. Overall, these findings suggest that overvaluation in public markets increases private firm investments and has beneficial effects on private firm investments by relaxing financing constraints. JEL Classifications: G32; M41. Data Availability: Data are available from sources identified in the paper.

This study tests whether nai¨ve trading by individual investors, or some class of individual investors, causes post-earnings announcement drift (PEAD). Inconsistent with the individual trading hypothesis, individual investor trading fails to subsume any of the power of extreme earnings surprises to predict future abnormal returns. Moreover, individuals are significant net buyers after both negative and positive extreme earnings surprises, consistent with an attention effect, but not with their trades causing PEAD. Finally, we find no indication that trading by individuals explains the concentration of drift at subsequent earnings announcement dates.