The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms
University of Washington
University of Pennsylvania - The Wharton School
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Center for Financial Studies (CFS); University of Pennsylvania - Wharton Financial Institutions Center; CESifo Research Network
Accounting Review, Vol. 81, No. 5, pp. 983-1016, 2006
This paper examines how capital market pressures and institutional factors shape firms' incentives to report earnings that reflect economic performance. To isolate the effects of reporting incentives, we exploit the fact that, within the European Union, privately held corporations face the same accounting standards as publicly traded companies because accounting regulation is based on legal form. We focus on the level of earnings management as one dimension of accounting quality that is particularly responsive to firms' reporting incentives. We document that private firms exhibit higher levels of earnings management and that strong legal systems are associated with less earnings management in private and public firms. We also provide evidence that private and public firms respond differentially to institutional factors, such as book-tax alignment, outside investor protection and capital market structure. Moreover, legal institutions and capital market forces often appear to reinforce each other.
Keywords: international accounting, earnings management, private companies, legal system, accounting harmonization, earnings properties
JEL Classification: G14, G15, G30, G32, K22, M41, M43, M47Accepted Paper Series
Date posted: March 23, 2006 ; Last revised: November 20, 2011
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