Does Stock Liquidity Affect Accrual-based Earnings Management?

This study investigates the effects of stock liquidity on earnings management. While prior research finds that liquidity has mixed effects on corporate governance, our baseline regression results show that an increase in stock liquidity is associated with an increase in discretionary accruals and revenues. To establish causality, we use two quasi-natural experiments that exploit exogenous increases in stock liquidity resulting from regulatory changes to the minimum tick size. The results of our difference-in-differences approach indicate that stock liquidity increases accrual-based earnings management. Additional analysis suggests that liquidity affects earnings management by magnifying the effects of takeover pressure and equity compensation.