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Jensen (2005) describes the extremely severe consequences of being substantially overvalued. I, therefore, hypothesize that in long-term a majority of highly valued firms would wish to avoid becoming substantially overvalued. Instead of inflating earnings, my conjecture is in long-term highly firms would depress earnings via earnings management as a signaling tool to try correcting the market. Using a sample of UK listed stocks during the 1995-2004 period, I find that in five years after being highly valued, firms consistently manage earnings downwards via spending more discretionary expenses and underproduction. Moreover, I find that such income-decreasing real operation management is only observable when the high valuation is firm-specific but not when the market highly values the whole industry. The evidence is robust across different approaches used to identify highly valued firms. My long-term real operation management evidence is, therefore, in line with the signaling hypothesis. Such evidence is original and very interesting, especially under the lights of the strikingly established evidence that highly valued firms engage in income-increasing abnormal accruals in short-term. Put together, I advocate an equilibrium story where highly valued firms signal to correct the market in long-term while trying to avoid an immediate correction in short-term.

Highly Valued Equity and Real Operation Management: Long-Term 'Detoxification'