Financial Reporting Transparency and Earnings Management

Abstract:     
Prior research indicates that greater transparency in reporting formats facilitates the detection of earnings management (EM). The current study investigates whether greater transparency also reduces EM attempts. In our experiment, 62 financial executives and chief executive officers decide which available-for-sale security to sell from a portfolio. We manipulate the transparency of comprehensive income reporting and the relationship of projected earnings to the consensus forecast in a 2 x 2 between-subjects design. When projected earnings are below (above) the consensus forecast, participants sell securities that increase (decrease) earnings. However, the rarely-used, more transparent format for reporting comprehensive income dramatically reduces both income increasing and income decreasing EM. Participants indicate they believe EM in the less transparent setting will improve stock price and have no effect on their reputation for reporting integrity, whereas EM in the more transparent setting will damage both. Results of this study suggest that more transparent reporting requirements will reduce EM attempts or change the focus of EM attempts to less visible methods.

Number of Pages in PDF File: 36

Keywords: reporting transparency, earnings management, comprehensive income, SFAS 130

JEL Classification: M41, M43, M44

working papers series