Purpose – The purpose of this paper is to investigate whether earnings management that surpasses a threshold is associated with market mispricing.Design/methodology/approach – The paper examines the level of discretionary current accruals (DCA) as a proxy for earnings quality. Operationally the threshold of earnings management is defined as the mean DCA, and it is assumed that highly managed firms (both income‐decreasing and income‐increasing) produce low‐quality earnings information. It is postulated that such management may lead to mispricing errors by investors who make incorrect adjustments for lower earnings quality.Findings – The evidence suggests that investors possess idiosyncratic perceptions toward earnings management. Investors of income‐decreasing firms tend to under‐adjust for analyst optimism, while investors of income‐increasing firms are inclined to over‐adjust for analyst optimism. In addition, investors of both types of highly managed firms appear to under‐adjust for earnings management....