The Effects of Managerial Discretion in Fair Value Accounting REgulation and Motivational Incentives to 'Go Along' with Management Analysts' Expectations and Judgments

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The current study examines the extent to which financial analysts expect firms to manage earnings when accounting rules allow a relatively high degree of discretionary choice and low level of transparency, and measures whether analysts' stock price estimates are upwardly biased when they are aware that management is taking advantage of the situation. We further investigate whether analysts' expectations and judgments in this regard are amplified in the presence of an incentive to "go along" with management's misleading financial information. A total of 44 experienced financial analysts participate in a between participants experiment, wherein those who are provided with misleading (non-misleading) information from management regarding the fair value of an impaired asset for which there is no active exchange market, expect management to recognize a downwardly biased (non-biased) asset impairment loss and issue commensurately higher (lower) stock price estimates. The results also show that analysts who have an incentive to go along with management anticipate a downwardly biased impairment loss and provide a higher stock price estimate, relative to analysts with no such incentive. Finally, the research findings indicate a significant interaction whereby the differential responses from analysts in the truthful and misleading conditions are greater in the presence, compared to absence, of an incentive go along with management.