Earnings Management Incentives and the Asymmetric Behavior of Labor Costs: Evidence from a Non-US Setting

Abstract

Earlier studies have shown that costs behave asymmetrically. Despite the fact that managerial intent is postulated to be an important driver, incentive issues have been largely ignored in the cost asymmetry literature. This paper examines the relationship between earnings management incentives and labor cost asymmetry in a sample of Belgian private companies during the period 1994 to 2006. We find that companies with earnings management incentives have a more symmetric cost pattern than companies without these incentives. However, this trend towards more symmetry is influenced by the extent to which companies use accruals to manage earnings. Further tests using detailed employee data show that managers with earnings management incentives are concerned with cost-cutting while those without earnings management incentives avoid firing employees to preserve their status.

Keywords: cost asymmetry, earnings management, labor costs

JEL Classification: M41