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Do Verified Earnings Reports Increase Investment? *
Author(s) -
Lunawat Radhika,
Waymire Gregory,
Xin Baohua
Publication year - 2021
Publication title -
contemporary accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.769
H-Index - 99
eISSN - 1911-3846
pISSN - 0823-9150
DOI - 10.1111/1911-3846.12646
Subject(s) - earnings , transparency (behavior) , limiting , business , investment (military) , profit (economics) , accounting , monetary economics , economics , microeconomics , computer science , engineering , political science , mechanical engineering , computer security , politics , law
A common view is that verified earnings reports encourage investment through improved transparency. We lack direct evidence on this foundational proposition because researchers cannot observe counterfactuals in which a manager either (i) must remain silent about performance or (ii) can make any statement about performance they desire, even a bald‐faced lie. We experimentally manipulate whether a manager can provide information to an investor by voluntarily disclosing a verified earnings report, communicating freely via unverifiable cheap talk, or both. Our experiment involves repeated interactions between an uninformed investor with funds that, if invested, generate uncertain gains, and a trustee‐manager who observes and then divides gains after they are realized. We hypothesize and find that (i) the provision of a verified earnings report leads to higher investment compared with a world in which reporting is not possible and (ii) the provision of a verified earnings report leads to more accurate cheap talk communication than when earnings reports are unavailable. Contrary to our prediction, we find that investment when both earnings reports and cheap talk are possible is statistically indistinguishable from investment when only cheap talk communication is available. Further tests reveal that a lack of verified earnings reports leads managers to sustain a partner's investment by providing high returns to the investor while also limiting (but not completely eliminating) deceptive communication and profit‐taking. Our main conclusion is that verified earnings reports promote investment on a stand‐alone basis by improving transparency, but the effect of greater transparency from earnings reports on investment is more nuanced when earnings reports can influence the disclosure of unverifiable information. The main implication of our evidence is that the greater transparency of management behavior with verified earnings reports is not unambiguously positive because making behavior more transparent can lead managers to change their behavior.