Earnings Manipulation and Expected Returns

Earnings Manipulation and Expected Returns

By
Daniel M. Beneish, Charles M. C. Lee, Craig D. Nichols
Financial Analysts Journal.
2013, Vol. 69, Issue 2, Pages 57-82

An accounting-based earnings manipulation detection model has strong out-of-sample power to predict cross-sectional returns. Companies with a higher probability of manipulation (M-score) earn lower returns on every decile portfolio sorted by size, book-to-market, momentum, accruals, and short interest. The predictive power of M-score stems from its ability to forecast changes in accruals and is most pronounced among low-accrual (ostensibly “high-earnings-quality”) stocks.  These findings support the investment value of careful fundamental and forensic analyses among public companies.