Earnings predictability or truthfulness? Which one investors care more about

Abstract

Purpose

This study aims to investigate the impact of earnings predictability and truthfulness on nonprofessional investors’ investment willingness.

Design/methodology/approach

Earnings predictability is captured by quarterly earnings autocorrelation, and earnings truthfulness is indicated by real earnings management (REM). The average of investment attractiveness and willingness measures investment willingness. The authors use experiments to isolate the impact of quarterly earnings autocorrelation and REM on investors’ investment behaviors.

Findings

From the 2 × 2 design, the authors observe that investors weight more on earnings predictability than earnings truthfulness.

Research limitations/implications

The generalization of the findings may be constrained for the following reasons. First, the authors use only one proxy, REM, to measure earnings truthfulness. In addition, the authors provide the participants, Amazon Mechanical Turk, with earnings predictability. Results may no longer hold if each participant has different understanding and analysis of earnings predictability.

Practical implications

In periods of unprecedented and severe financial uncertainty (i.e. the COVID-19 pandemic), investors rely more on earnings predictability than on earnings truthfulness. The study assists managers to strategically emphasize the predictability of earnings to attract investors, especially when firms face financial challenges or uncertainty.

Social implications

This study contributes to understanding investor behavior and the critical role of earnings predictability and truthfulness in shaping investment decisions.

Originality/value

This paper contributes to the literature of earnings properties in financial reporting, particularly by shedding light on the nuanced interplay between earnings predictability and earnings truthfulness. The research also demonstrates that elevated earnings autocorrelation indirectly stimulates investment willingness by enhancing the investors’ perception of earnings persistence of targeted firms.

Citation

Fan, S. and Zhou, Y. (2024), "Earnings predictability or truthfulness? Which one investors care more about", Journal of Financial Reporting and Accounting, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/JFRA-11-2023-0642