This paper examines the implications of investor expectations for the joint determination of earnings manipulation and asset prices. Three alternative models of investor expectations are studied: constant-gain learning, regime-shifting beliefs, and accounting-information-system (AIS) beliefs. I use the simulated method of moments (SMM) to estimate the most plausible model that matches the actual data. AIS beliefs and regime-shifting beliefs are shown to best explain the empirical moments of 63% and 32% of S&P 500 firms, respectively. Regression analysis suggests that the three models offer different predictions on the existence and magnitude of several empirical regularities including a positive earnings response coefficient, the discretionary accruals anomaly, and return momentum.
All Science Journal Classification (ASJC) codes
- Economics and Econometrics
- Control and Optimization
- Applied Mathematics