IS THE MISPRICING OF SOCIALLY AMBIGUOUS FIRMS EXPLAINED BY EARNINGS MANAGEMENT

Abstract

This study examines the relationship between earnings management and the stock pricing of socially ambiguous “Grey” firms. “Grey” firms are firms that are both socially responsible and irresponsible along different corporate social responsibility (CSR) dimensions. Using accounting data from 1991 to 2010, I find that “Grey” firms are more likely to engage in earnings management relative to other types of firms. Specifically, they are likely to engage in (1) real activities manipulation and (2) manipulation of earnings through accruals. Portfolios of “Grey” stocks that are high in earnings management earn an annual abnormal return of between 3.2% to 5.6% relative to “Neutral” portfolio of firms that are neither socially responsible nor irresponsible. Examining the average return of firms over the twenty-year period, earnings management is able to moderately explain the mispricing of “Grey” firms relative to “Neutral” firms. The explanation is robust after controlling for institutional holdings, short-sell interest and liquidity constraints. Overall, earnings management is able to explain to a moderate extent the phenomenon of “Grey” firms mispricing, but it is not the sole driving factor behind the mispricing.