Earnings management and institutional investor trading prior to earnings announcements

Abstract

Purpose

The purpose of this paper is to investigate if earnings management affects the trades of different investors prior to earnings announcements.

Design/methodology/approach

Using a unique account-level trading data set from the Chinese stock market, the author investigates the different investor trading patterns prior to earnings announcements.

Findings

The author obtains direct evidence to show that: first, institutional investors, particularly active ones, tend to sell (buy) stocks before negative (positive) earnings surprises; second, institutional investors buy stocks intensively with the lowest earnings management and the highest earnings surprises, and the trading patterns are primarily driven by active institutions. No significant trading pattern is observed on the stocks with negative earnings surprises; and third, the author uses a natural experiment in accordance with the Chinese accounting standards reform to address endogeneity, and the causality of the results still holds.

Originality/value

The findings provide clear evidence by emphasizing the importance of earnings management in the formulation of investor decisions.

Citation

Liu, S. (2019), "Earnings management and institutional investor trading prior to earnings announcements", China Finance Review International, Vol. 9 No. 1, pp. 22-50. https://doi.org/10.1108/CFRI-01-2018-0010