The Reactions of Analysts and Institutional Investors to Firms’ Real Activities Management

• Main Authors: CHUNG, Sung Gon, LEE, Joonho
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 2012
• Subjects: Accounting; Portfolio and Security Analysis
• Online Access: https://ink.library.smu.edu.sg/soa_research/998; http://aaahq.org/AM2012/abstract.cfm?submissionID=1553
• Institution: Singapore Management University

This study examines the effect of real activities management (RAM) on firms’ future performance and the reactions of analysts and institutional investors to RAM. The issue of whether RAM has a positive or negative effect on firms’ operating performance is not conclusive in the prior literature. We posit that RAM has a direct negative effect on firms’ future sales and present the confirming evidence. Our analysis of the response of analysts to RAM reveals that analysts lower their sales forecasts upon observing RAM, supporting the notion that they understand the negative effect of RAM on firms’ future sales. We also find that institutional investors sell their stocks in firms that show signs of RAM. Recent studies report that tighter accounting standards can prompt RAM. Our evidence is important in this context because it shows that some market participants are able to observe RAM and that they penalize those firms accordingly.