Advantageous Comparison and Rationalization of Earnings Management

46 Pages Posted: 10 Aug 2012 Last revised: 1 Mar 2014

See all articles by Tim Brown

Tim Brown

University of South Carolina - Department of Accounting

Multiple version iconThere are 2 versions of this paper

Date Written: February 26, 2014

Abstract

This paper proposes that psychological factors can change a manager’s beliefs about earnings management when they choose to engage in it. I show that, under certain circumstances, engaging in a small amount of earnings management alters a manager’s beliefs about the appropriateness of the act, which may increase the likelihood of further earnings management. Specifically, I predict and find in two experiments that participants who initially choose to manage earnings are motivated to rationalize their behavior. Participants who are exposed to an egregious example of earnings management (which are commonly the focus of enforcement actions and press reports) have the opportunity to rationalize their behavior through a mechanism called “advantageous comparison”, where participants compare their behavior against the egregious example and conclude that what they did was relatively innocuous and appropriate. My analysis also indicates that presenting participants with an example of earnings management which is similar to the initial decision they made mitigates advantageous comparison. These results have implications for academics interested in how earnings management, and perhaps fraud, can accrete over time and for regulators and practitioners who are interested in preventing it.

Keywords: earnings management, slippery slope, rationalization, advantageous comparison, SEC enforcement releases

JEL Classification: M4

Suggested Citation

Brown, Tim, Advantageous Comparison and Rationalization of Earnings Management (February 26, 2014). Journal of Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2127423 or http://dx.doi.org/10.2139/ssrn.2127423

Tim Brown (Contact Author)

University of South Carolina - Department of Accounting ( email )

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