Market reaction to the interaction between top management tone and earnings management : evidence from South Africa

Abstract

South Africa has been severely impacted by several high-profile corporate scandals, with significant financial manipulation involving both the content of financial statements and the tone set by top executives. Notably, CEOs such as Markus Jooste from Steinhoff have been accused of misleading investors through both earnings management and the use of an authoritative management tone. This study investigates the market's reaction to the interactive effect of top management tone and earnings management, employing a short-window event study methodology. The tones of two distinct management styles—autocratic and pragmatic—are examined by analysing CEO statements using the DICTION textual analysis software. The sample comprises 944 firm-year observations spanning from 2011 to 2018. The results indicate that the market did not respond to earnings management in isolation. However, a significant negative market reaction was observed when earnings management occurred in conjunction with an autocratic tone. This suggests that South African investors are particularly attuned to multiple signals of potential fraud and will adjust their valuations accordingly. The findings underline the importance of considering not only financial disclosures but also the behavioral cues given by top management in assessing firm performance and risk. Investors, regulators, and analysts must therefore remain vigilant to the combined risks posed by earnings manipulation and the tone of management communications. The study contributes to the limited literature on the stock market's response to the interplay of earnings management and management tone, particularly in the context of South Africa, and is the first to explore the combined effects of these two forms of manipulation.