Earnings Quality and Market Performance in LATAM Corporations: A Combined Agency and Cognitive Approach to Investors Perceptions of Managerial Information

Abstract

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This Chapter studies the impact of financial reporting quality on firms market performance in a sample of LATAM corporations, using this data to examine the perception processes of investors as a mediating variable between reporting quality and market performance. We infer that, especially in contexts of high information asymmetry, investors are not able to effectively discern the quality of the information they are provided with, and can therefore be misled in their investment decisions by managerial opportunism. Our theoretical framework is built upon a combined agency theory and cognitive approach, around which we model earnings management as a proxy for financial reporting quality. We thereby seek to provide a valuable method to better understand how investors could be making suboptimal choices as a consequence of managers opportunistic behaviour. Empirically, we use the Generalized Method of Moments (GMM) model, hypothesizing that a positive relationship should be observed between the opportunistic manipulation of earnings (that is, the misuse of accounting accruals) and the firm s market performance (that is, the consequential behaviour of investors). Through this pioneering methodology, applied to the relatively under-researched LATAM region, we find that: 1) Financial data are identifiably and consistently manipulated through discretionary accruals in these countries. 2) As manipulation increases, markets do tend to appear more attractive to investors. 3) The elasticity of the market reaction to this manipulation is higher in what we term opaque countries. Overall, we hope our research will serve as a generalizable method from which to derive policy recommendations for investors, managers and other agents involved with and impacted by the quality of the financial reporting process.