Earnings Management and Enforcement of Accounting Standards – Evidence from Germany

Abstract:     
According to Recital 16 of Regulation EC No. 1606/2002, the Commission of the European Union intends to develop a common approach to financial reporting enforcement. Currently efforts are taken, in particular by the European Securities and Markets Authority (ESMA), to establish a cross-jurisdictional financial reporting enforcement. This paper contributes to the discussion of standardized Europe-wide enforcement mechanisms by assessing the German enforcement system. Prior research has exposed that the "name and shame"-mechanism inherent to the German enforcement system – companies with enforcement error findings are obligated to publicly disclose details about the error finding – leads to significant (but low) negative capital market reactions upon enforcement error announcements. We emphasize that the "name"-mechanism of the German two-tier enforcement system, a mixed model consisting of a private body and a governmental authority, works efficiently as we find that companies with error findings exhibit a significantly higher degree of earnings management than firms with none. However, our empirical results show that the "shame"-mechanism needs to be improved in order to foster accounting quality as we show that companies with error findings maintain a high level of earnings management in the consecutive periods after an error finding.

Number of Pages in PDF File: 45

Keywords: Enforcement, IFRS, Accounting Error, Earnings Management, Accounting Quality

JEL Classification: K22, M41, M48

working papers series