N° 17-03: Earnings Management and the Role of Moral Values in Investing

In this study, we use earnings management to examine (1) how investors regard a CEO’s commitment to honesty and (2) the impact of their perceptions, in light of their own moral values, on their investment decisions. In two laboratory experiments using students as investor proxies, we find that investors perceive a CEO as being more committed to honesty when they believe the CEO has engaged less in earnings management. A one standard deviation increase in a CEO’s perceived commitment to honesty, compared to that of another CEO, leads to a 40% reduction in the importance the investors assigned, when making investment decisions, to differences in the two CEOs’ claimed future returns. This effect is particularly pronounced among investors with a proself value orientation. For prosocial investors, their moral values and those they attribute to the CEO directly influence their investment decisions, with returns playing a secondary role. Our findings contrast with the idea, implicit in the literature on ‘sin’ stocks, that morality is a niche concern. By contrast, we find that moral values play a significant role for distinct types of investors and that they influence investment decisions for both moral and pecuniary reasons.