Investors' reaction to profit management in companies listed on the Tehran Stock Exchange

Dissertation for Master's Degree in Accounting

Abstract

In the conditions of the realism of the presented financial statements, the profit based on the accrual accounting system should be able to reflect valuable information about the company's current situation and future prospects to the market. In this case, the profit may reflect the personal interests of the managers and cause analysts' forecast errors and cause incorrect valuation of the profit by the market. Now, this research was aimed at examining the issue of whether profit management exceeding the threshold will cause the market to mislead or not. By applying the mentioned restrictions, 138 companies accepted in the period of 6 years between 1386 and 1391 in Tehran Stock Exchange were selected as the sample of this research. The result of the first hypothesis test shows that at the 99% confidence level, there is a significant direct relationship between profit forecasting error and profit management. Confirmation of this hypothesis means that by manipulating profit through accruals, there is a significant difference between the actual profit per share and the expected profit per share. The results of the second hypothesis test show a significant positive relationship between profit forecasting error and abnormal returns of new stocks entering the stock market, which ultimately indicates the information content of the profit variable. In other words, the announcement of the expected profit causes a deviation in the average abnormal return rate of stocks. In general, the result of this research shows that if the managers make mistakes in their calculations to predict the next year's profit or change their forecasts in accordance with the increase in the percentage of profit forecast errors and the increase in the number of revisions in the forecast by managers, investors demand a higher rate of return for their capital. Companies that do not reach their expected profit or constantly change their forecasts do not have particular stability, so they may not meet investors' expectations.

Key words: profit management, abnormal stock returns, profit forecast error, actual profit, forecasted profit

The field of investment and behavior with money is always thought of by humans. They do not act rationally, and precisely for this reason there is a special field of research where the strange behavior of people in these areas is investigated. Economic theories are mainly formulated on the basis that people behave rationally and that available information is used in the investment process. This assumption is the basis of market efficiency theory. But research shows that there is evidence that rational behavior is not as universal as we think. Knowing the decision-making process of participants in the stock market is an important issue for supervisors and investors. In most researches in this field, researchers have tried to study and understand the investment behavior of market participants and then the effect of these factors on the price of securities.

Because the behaviors that affect the investment decisions of market participants are of particular importance Especially in the last decade, financial researchers have tried to explain and find the causes of certain cases with the help of other sciences such as psychology, social sciences and physics. The use of "psychological achievements in economic theories led to the formation of behavioral finance". No? In other words, investors in these markets react more or less than expected to new information. Stock market reactions to advertisements and news are different, and in some cases, the reaction of rational people is not rational and causes anomalies, such as over-increasing or under-pricing. Although the market realizes its mistake after the passage of time and returns to the equilibrium state, nevertheless, such behavior is considered a type of irrational behavior in the market, which can be a negative response to the uncertainty perceived by investors. People's expectations are subject to their predictions, which are sometimes ineffective. Understanding the source of these inefficiencies can have important applications for studying the rationality of investors and market efficiency (Mahmodi, 2010, p. 22).  

One of the main concepts in the field of behavioral finance is perspective theory[1] and reference point[2]. Perspective theory was presented by Kahneman[3] and Tversky[4] in 1979. In the form of this theory, they showed that "the amount of satisfaction obtained from a certain amount of profit is less than the dissatisfaction obtained from the same amount of loss". Prospect theory is explained by the value function. The value function [5], S-curve is a shape that has a reference point. The reference point determines whether investors are risk-taking or risk-averse, in such a way that below the reference point, investors are risk-taking and above it, risk-averse (Weisbord [6], 2013).

The perspective theory and the reference point is one of the topics discussed in the behavioral finance paradigm that describes the position of people at the time of decision. Empirical evidence shows that investors choose points as their profit and loss reference points in buying and selling decisions. If the price is lower than the reference point, they postpone their sale, and as a result, the volume of transactions also decreases, and if the price is higher than the reference point, they sell shares, which leads to an increase in the volume of transactions. The evidence shows that investors choose points as reference points for their profit and loss in buying and selling decisions. When the price is lower than the reference point, they postpone their sale, and as a result, the volume of transactions also decreases, and if the price is higher than the reference point, they sell shares, which leads to an increase in the volume of transactions. Among the things that have been examined as a reference point in past researches are the ceiling and floor prices of stocks in the past year and the purchase price. Most of the research conducted in developed stock markets has confirmed these points as reference points (Wisebord, 2013).

By buying stock, the investor takes a risk and gets a return, so the most important factors that are effective in deciding to buy securities are its return and risk compared to other investment opportunities. In the same way, the yield and risk of each share sheet is comparable with other securities. Two categories of internal and external factors affect stock returns. External factors include: economic cycles, inflation, government regulations, the competition of the country's economic policies, political and economic conditions, and so on. And the internal factors include the management decisions of the internal systems of the business unit, the size of the company. In order to encourage the investor, the investment should potentially have a positive rate of return. This will cause the investor to gain more wealth in the future and as a result (compared to the possibility or opportunity of current consumption) to benefit from more facilities and opportunities, hence the expectation of obtaining a return causes the investor to postpone his consumption. Dividends have a positive and negative effect on the behavior of investors when buying and selling shares, and for this reason, it is considered as a main parameter (Sadeghpour, 2014).

Information is considered an important strategic tool in decision-making, and the quality of decisions depends on the accuracy, precision and timeliness of the information available to people at the time of decision-making. In the financial markets, this information can be reflected in the form of various signs, symptoms, news and forecasts from inside or outside the company and can be made available, causing reactions and as a result, changes in stock prices (Rai and Telangi, 2013).

The behavior of investors in the stock market, the way of decision making, the allocation of monetary resources, pricing, evaluation, and the efficiency of companies. Ambiguous conditions and mistakes that are rooted in human psychology cause investors to make mistakes in forming their expectations and, as a result, show certain behaviors when investing in financial markets (Sinai, 2018).

One of the basic criteria for making decisions in the stock market is stock returns. (Qaemi, 1385).

In an efficient market, the price of securities reflects a set of all available information, and new information quickly affects the price of securities, and investors make decisions based on the available information and their expectations of future securities returns.