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Board Interlocks and Earnings Management Contagion

54 Pages Posted: 12 Dec 2010 Last revised: 6 Feb 2013

Peng-Chia Chiu

The Chinese University of Hong Kong (CUHK)

Siew Hong Teoh

University of California, Irvine - Accounting Area

Feng Tian

Hong Kong Polytechnic University

Date Written: November 15, 2010

Abstract

We test whether earnings management (like a virus) spreads from firm to firm via board connections of shared directors (virus carriers). We use earnings restatements to identify firms that managed earnings and to identify the period when these firms manipulated earnings. We consider firms as infectious in the period when they manipulated earnings. We test whether the directors of the infected firms carry these earnings management behaviors to susceptible firms on whose boards they also sit on.

We find evidence of earnings management contagion in firms with interlocked boards. A firm sharing a common director with an earnings manipulator is more likely to manage earnings. The contagion is stronger when the shared director has a leadership position (e.g. board chair or audit committee chair) or an accounting-relevant position (audit committee member) in the susceptible firm. Contagion effects are not due to reverse causality effects, common industry shocks, geographical proximity, or common auditor firm. Contagion effects exacerbate earnings management incentives, such as M&A activities or situations associated with accounting fraud. Overall, the evidence supports the idea that economic behaviors such as earnings manipulation also spread through private social networks, and not just through public information channels.

Keywords: Earnings Management, Restatements, Board Interlocks, Social Networks, Contagion, Governance

JEL Classification: M40, M41, M49, G34, G39, D83

Suggested Citation

Chiu, Peng-Chia and Teoh, Siew Hong and Tian, Feng, Board Interlocks and Earnings Management Contagion (November 15, 2010). The Accounting Review, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1723714 or http://dx.doi.org/10.2139/ssrn.1723714

Peng-Chia Chiu

The Chinese University of Hong Kong (CUHK) ( email )

Hong Kong
Hong Kong

Siew Hong Teoh (Contact Author)

University of California, Irvine - Accounting Area ( email )

Irvine, CA 92697-3125
United States

Feng Tian

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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