+Next, I examine the behavior of investors, in an effort to assess whether

investors
understand the earnings implications of RM. The evidence as to whether
investors recognize
earnings management (specifically accruals) is mixed. On the one hand,
investors seem to not
fully see through earnings management as reflected in abnormal accruals
(Sloan, 1996; Xie,
2001). On the other hand, in the banking and insurance industries, loan
and policy loss reserves are two major accounts subject to management
discretion and investors do understand the information in these accruals
(Wahlen, 1994; Beaver and Engel, 1996; Liu et al., 1997; Beaver and
McNichols, 2001). To ascertain whether investors detect and, therefore,
react to RM, I examine the extent to investors incorporate the future
earnings implications of RM into stock prices.

+Efficient pricing means the accounting information is appropriately

understood and used in market price formation. Mispricing occurs when
the accounting information is misunderstood and inappropriately used in
price formation. This is the view followed in the extant earnings
management literature (e.g.,Subramanyam, 1996; Sloan, 1996; Xie,
2001).
I consider the motivation of REM based on either the efficient contracting
hypothesis or the managerial opportunism hypothesis, and under two
competing market efficiency hypotheses: the efficient market hypothesis
(EMH) and the investor fixation hypothesis.