We propose and test the spillover effect of earnings management by a set of firms on investors’ reaction to other similar firms. We first document that China’s de-listing policy separates public firms into a high and a low earnings management segments based on accounting earnings. A large proportion of firms in the high earnings management segment are suspects of earnings management which has a spillover effect on all the other firms in the same segment. We show that investors can not identify which firms have managed their earnings in the high earnings management segment. Hence, investors distrust and react less to earnings announcements by all firms in the high earnings management segment. Moreover, firms in the high earnings management segment suffer from less stock price informativeness and higher risk factor loadings. Lastly, we present causal evidence on the spillover effect by studying China’s public firms that exogenously shift from low to high earnings management segment due to the 2007-08 financial crisis in the U.S.. 

Keywords: Earnings Management, Spillover Effect,Investor Reaction, Price Informativeness​