Does Earnings Management Affect Firms’ Investment Decisions?

ABSTRACT: This paper examines whether firms manipulating their reported financial results make suboptimal investment decisions. We examine fixed asset investments for a large sample of public companies during the 1978–2002 period and document that firms that manipulate their earnings—firms investigated by the SEC for accounting irregularities, firms sued by their shareholders for improper accounting, and firms that restated financial statements—over-invest substantially during the misreporting period. Furthermore, following the misreporting period, these firms no longer over-invest, consistent with corrected information leading to more efficient investment levels. We find similar patterns for firms with high…