Earnings Management in Response to Stock Price Pressure: Evidence from Fire Sales (and Purchases) by Mutual Funds

This paper examines whether managers manipulate earnings in response to fire sales (and purchases) of stocks by mutual funds. I find that managers engage in upward earnings management when facing downward price pressure driven by fire sales of mutual funds. I find no evidence that managers engage in downward earnings management when their stocks are fire purchased by mutual funds. My results become stronger for firms with more illiquid stocks, firms under tighter financial constraints and firms issuing new debt. I also find that earnings management increases stock prices in the short term and helps stock prices return to “normal” levels in the long run. Collectively, my evidence suggests that downward price pressure caused by fire sales of mutual funds leads to upward earnings management, which in turn speeds up price recovery.