Defence Measures and Earnings Management in an Owner Dominant Context

Abstract

The aim of this research is to examine the effect of defensive measures (DMs) on earnings management in an owner dominant environment such as Continental Europe, where control is assumed to be exercised by large shareholders. Thus, compared to the manager dominant context of the US/UK, in the owner dominant environment firms operate in a setting with weaker investor protection, less developed capital markets and a larger presence of dominant owners with the ability and incentives to influence corporate decisions. Using a defensive index that captures the level of defence measures in Spanish listed firms’ by-laws, we find a positive relation between the presence of DMs and earnings management. Our results are consistent with DMs promoting dominant shareholders’ entrenchment and increasing their incentives to manage earnings in order to avoid unnecessary scrutiny from market participants and regulators in a context where political rent-seeking activities are prevalent.

Keywords: Defence measures, earnings management, owner dominant context

JEL Classification: G32, M41, G29