While prior research shows several instances where

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While prior research shows several instances where managers attempt to manage earnings to avoid reporting losses and earnings decreases (Burgstahler and Dichev 1997 a; DeGeorge et al. 1999 ; Bartov et al. 2002 ; Beatty et al. 2002 ; Moehrle 2002 ; Das and Zhang 2003 ; Dechow et al. 2003 ), we find no evidence that such actions should be motivated by market imposed penalties. 22 The lack of evidence for a threshold effect is consistentwithresultsinPayneandThomas( 2008 ).Ifthemarketanticipatesanearnings increase or a profit, as indicated by the analyst forecast, then realizations of these thresholds would not be expected to elicit a stock price response. Dispersion , Book-to-Market , and PreReturn are significant in the predicted direction for both samples, and Market Value is significant for the full sample. The coefficient on Expected Growth is not significantly different from zero. 4.4 Additional tests The results documented in Tables 4 and 5 are consistent with the cost of capital hypothesis . The extensive controls we employ for nonlinearities in the returns/ earnings relation and the short-window research design facilitate our attributing the documented results to cost of capital (a denominator effect in Eq. 1). Nevertheless, we conduct additional sensitivity analyses to examine the robustness of our main results. 21 When our controls for nonlinearity ( FELin and RevLin ) are not included in the model, the coefficient on FE is 12.478 and the coefficient on Revision is 7.723. The coefficient on D Dispersion remains significantly negative ( - 0.011; t = - 7.26). 22 Managers’ compensation packages or corporate goals could be partially based on meeting certain earnings thresholds, including reporting increasing earnings or profits, which could motivate managers to achieve these thresholds absent valuation implications. 24 L. Rees, W. Thomas 123
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4.4.1 Association between change in dispersion and cost of capital We examine the construct validity of using D Dispersion as a link to cost of capital by regressing the estimated change in cost of capital on the independent variables in Eq. 2. Finding a significant association between the change in cost of capital and D Dispersion increases our confidence that the price reaction results reported in Tables 4 and 5 can be attributed to the cost of capital hypothesis . We estimate cost of capital using the model in Ohlson and Juettner-Nauroth ( 2005 ), which expresses cost of capital as a function of the forward EPS-to-price ratio and two measures of growth in expected EPS. Consistent with the notion that dispersion is associated with cost of capital, we find that the ranked value of D Dispersion is positively associated with change in cost of capital ( t - value = 2.16). 23 These results support our primary conclusions. 4.4.2 Reconciliation with concurrent research In a concurrent study, Dimitrov et al. ( 2007 ) test the theory developed by Miller ( 1977 ) by examining the relation between earnings announcement period returns and various proxies for differences of opinion across investors. One proxy employed for differences of opinion is analyst forecast dispersion. Specifically, the authors
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