How uncertain is the market about managers' reporting objectives? Evidence from structural estimation

Abstract

Theory suggests that the market's uncertainty about managers' reporting objectives is an important source for reporting biases (Fischer and Verrecchia 2000), yet little empirical work exists on gauging such uncertainty. We derive a simple structural estimator of this uncertainty, incorporating cross-sectional properties of prices, earnings and restatements. This approach enables us to assess an average level of uncertainty. We show that investors' uncertainty about reporting incentives, albeit non-zero, are generally small. Given the link between uncertainty and reporting biases, our large sample evidence also supports the conjecture that earnings management is not as rife as what prior accounting academic publications would make one believe (Ball 2013). We also characterize the variation in the magnitude of uncertainty across industries and subsamples of firm size and growth.