We examine earnings management practices of insider controlled firms across 22 countries to shed light on the link between consumption of private benefits and earnings management. Insider controlled firms are associated with more earnings management than noninsider controlled firms in weak investor protection countries. Consistent with the private benefits motive, insider controlled firms with greater divergence between cash‐flow rights and control rights are associated with more earnings management in these countries. Growth opportunities attenuate the association between insider control and earnings management even in weak investor protection countries. We also find some weak evidence that insider controlled firms are associated with less earnings management in strong investor protection countries. Overall, our results highlight a strong link between private benefits consumption and earnings management

We empirically examine the effects of economic policy uncertainty (EPU) on earnings management in Japan. We find that EPU is negatively associated with earnings management, indicating that managers have incentive to reduce earnings management when EPU increases. We then examine the monitoring roles of various entities, focusing on the main bank that holds equity in their client firm. We find that the relationship between EPU and earnings management is less pronounced for firms with a main bank. The result is consistent with the view that the main bank’s monitoring role works well in normal times, resulting in less room for management to improve earnings quality when EPU is high. We find a similar result when considering firms with and without analyst coverage. These results suggest a moderating role of main banks and analysts in the relationship between EPU and earnings management. Finally, we find that the effect of EPU differs depending on subcategories on policy uncertainty and the extent of each firm’s exposure to that type of uncertainty

What is the role of information intermediaries in corporate governance? This paper examines equity analysts’ influence on managers’ earnings management decisions. Do analysts serve as external monitors to managers, or do they put excessive pressure on managers? Using multiple measures of earnings management, I find that firms followed by more analysts manage their earnings less. To address the potential endogeneity problem of analyst coverage, I use two instrumental variables based on change in broker size and on firm's inclusion in the Standard & Poor's 500 index, and I find that the results are robust. Finally, given the number of covering analysts, analysts from top brokers and more experienced analysts have stronger effects against earnings management

We provide evidence on earnings management by exploiting temporary exogenous shocks to utility firms’ sales arising from weather variation. We find that sample firms’ sales are highly sensitive to annual changes in average temperatures in the region where the firm operates, but this sensitivity disappears quickly as one moves down the income statement. This evidence, while indirect, is suggestive of earnings management activities. In search of direct evidence, we study charitable giving decisions by sample firms and uncover a significant positive sensitivity of charitable spending to weather-driven demand shocks, behavior that is highly consistent with the presence of real earnings management efforts. We find no convincing evidence supporting possible alternative explanations for this evidence, but we do find limited support for the presence of a larger giving–weather relation when earnings management incentives are likely to be elevated. If other real decisions with similar characteristics scale proportionally to charitable giving, our findings suggest that the overall magnitude of real earnings management activities could be quite substantial

Using a large sample of multinational corporations (MNCs), we examine the location of earnings management within the firm. We posit and find that MNCs manage their consolidated earnings through an orchestrated reporting strategy across subsidiaries over which they exert significant influence. Specifically, we find that headquarters' influence on subsidiary earnings management increases with the degree of subsidiary integration and the extent of earnings management opportunities. Most importantly, we provide evidence that MNCs exploit regulatory arbitrage opportunities arising from cross-country differences in institutional quality. We document that, in response to exogenous improvements in the quality of their home-country institutions, MNCs rebalance their reporting strategies by clustering earnings management in subsidiaries from countries with more lenient regulations. Taken together, our findings yield important insights on the drivers of earnings management location within the firm and highlight the need for better cross-country coordination in regulatory design

In this paper, we model earnings management as a consequence of the interaction among self‐interested economic agents ‐ namely, the managers, the shareholders, and the regulators. In our model, a manager controls a stochastic production technology and makes periodic accounting reports about his or her performance; an owner chooses a compensation contract to induce desirable managerial inputs and reporting choices by the manager; and a regulatory body selects and enforces accounting standards to achieve certain social objectives. We show that various economic trade‐offs give rise to endogenous earnings management. Specifically, the owner may reduce agency costs by designing a compensation contract that tolerates some earnings management because such a contract allocates the compensation risk more efficiently. The earnings‐management activity produces accounting reports that deviate from those prescribed by accounting standards. Given such reports, the valuation of the firm may be nonlinear and s‐shaped, thereby recognizing the manager's reporting incentives. We also explore policy implications, noting that (1) the regulator may find enforcing a zero‐tolerance policy ‐ no earnings management allowed ‐ economically undesirable; and (2) when selecting the optimal accounting standard, valuation concerns may conflict with stewardship concerns. We conclude that earnings management is better understood in a strategic context that involves various economic trade‐offs

We find that in general, both accrual-based and real earnings management decrease after the passage of shareholder-sponsored governance proposals. However, when accounting for the type of proposal, we observe significant heterogeneity in the effects on earnings management. Specifically, proposals focused on changing the governance structure (e.g., board independence) lead to reductions in both types of earnings management, whereas proposals specifically targeted at improving financial reporting quality lead to decreased accrual-based earnings management but increased real earnings management. The results suggest that constraints on accrual-based earnings management induce a shift toward real earnings management. Our paper indicates that the nature of the shareholder proposal has a significant impact on shareholder intervention

Using data from China, we examine whether and how the incentive to boost GDP growth at the government level affects earnings management at the firm level. We find that firms in provinces with GDP growth lower than the national level or the average of the adjacent provinces are more likely to engage in earnings management than firms in other provinces. Specifically, they are more likely to inflate revenues, overproduce, and delay asset impairment losses. The aggregate earnings management induced by GDP growth incentives accounts for about 0.5% of GDP. The results are stronger for local state-owned enterprises, in provinces with a lower level of marketization, for firms in provinces with younger governors, and in the years immediately prior to the turnover of provincial officials. Overall, this paper provides systematic evidence on how firms engage in earnings management to boost the GDP growth in their provinces

We reexamine the positive association between stock option vega and earnings management previously documented by Armstrong, Larcker, Ormazabal, and Taylor (2013; henceforth, ALOT). In contrast to ALOT, prior empirical research and practitioner literature emphasizes earnings management's goals of increasing stock price and reducing volatility. Specifically, we assess whether the association is robust to (i) employing discretionary accruals that are less prone to misspecification, (ii) focusing on a more recent time period, and (iii) including additional controls for period‐specific factors. Our main findings are as follows. First, we fail to find a positive association between vega and earnings management after controlling for performance‐related misspecification in discretionary accruals. Second, we find no association between vega and earnings management in a more recent time period, suggesting the results of ALOT may be sensitive to period‐specific factors. Last, the positive association vanishes when we control for year fixed effects, growth opportunities, or monitoring, suggesting the original results of ALOT's research may be sensitive to correlated, omitted variables. Overall, our results question the extent to which vega incentivizes earnings management. Our results may be of interest to boards of directors in designing executive compensation contracts, to regulators in crafting policies that maintain high levels of financial reporting quality, and to researchers seeking to identify settings where earnings management incentives are most salient

Despite a recent focus on the ethics of earnings management, research has generally not examined the specific ethical dilemma that arises when a choice to engage in earnings management results in positive organizational consequences. This study focuses on the consequences of earnings management behavior in response to the question: Do the ends of positive organizational consequences justify the means of earnings management? We investigate manager evaluations of, and reactions to, a scenario in which a hypothetical employee makes a choice whether or not to engage in earnings management behavior, with consequences that are either favorable or unfavorable to the organization. Two hundred and sixty-four experienced managers provided responses to the scenario in a controlled experimental research design. The results indicate that managers may be motivated to discount the ethical impact of earnings management behavior when the consequence has a favorable impact on the organization—implying that the ends justify the means. This finding, in turn, suggests that incrementalism, or the ethical “slippery slope” of overlooking seemingly minor ethical breaches, can undermine efforts to establish a strong ethical tone throughout the organization. Implications of these findings for corporate governance and future research are discussed