Does Competition Affect Earnings Management? Evidence from a Natural Experiment

We examine how exogenous increases in foreign competition affect firms’ earnings management behavior, using import tariff reductions as a natural experiment. Using a Difference-in-Differences framework, we find a significant increase in earnings management (and financial restatements) after tariff reductions that intensify foreign competition. The effect of tariff reductions on earnings management is more pronounced for firms operating in industries that are more competitive, subject to tighter financial constraints, with greater financing needs, and subject to weaker external monitoring. Our findings are consistent with Shleifer (2004), who argues that competition might induce more unethical behavior (such as earnings management).

Keywords: earnings management, foreign competition, trade liberalization

JEL Classification: G15, G31, G38

Suggested Citation: Suggested Citation

Lin, Chen and Officer, Micah S. and Zhan, Xintong, Does Competition Affect Earnings Management? Evidence from a Natural Experiment (September 23, 2015). Available at SSRN: https://ssrn.com/abstract=2357783 or http://dx.doi.org/10.2139/ssrn.2357783