This study examines earnings persistence and valuation implication for firms with large magnitudes of real activity earnings management. This study examines whether investors react rationally and consistently to firms with large magnitude of upward or downward REM. Our finding indicates that the persistence of future earnings, accruals and operating cash flows declines for firms with large REM. After the passage of Sarbanes-Oxley Act of 2002, managers’ preference to REM makes it more difficult for investors to consistently evaluate the persistence of future earnings in earnings forecast and price valuation since REM affects both accruals and operating cash flows. It is debatable that SOX improves the reliability of financial reporting and helps investors understand the financial reality of firms’ business operation.
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