The Influence of Strong Shareholders on Earnings Management

Abstract:     
Presumably, shareholder rights aim to better align the actions of managers with the interests of shareholders; however, it is not clear from prior research whether such alignment mitigates or exacerbates managers’ propensity to manage earnings. We document that when shareholder rights are stronger, managers are more likely to manage earnings upward when meeting or slightly beating analyst expectations. We also find evidence consistent with firms with strong shareholders managing earnings downward when easily beating analyst expectations, although the propensity for this behavior is equally observed for firms with weak shareholder rights. Additional tests suggest that the propensity of firms with strong shareholder rights to manage accruals upward is more severe when the firm has established a history of meeting expectations, institutional ownership is low, or when CEO ownership is absent. Overall, the results are not consistent with the traditional expectation that shareholder rights serve as a governance role that reduces discretionary reporting behavior. Given recent demands to enhance shareholder rights, our study highlights an interesting financial reporting consequence.

Number of Pages in PDF File: 41

working papers series