Competing Reporting Objectives and Financial Reporting Quality
49 Pages Posted: 16 Oct 2014 Last revised: 6 Apr 2015
Date Written: April 5, 2015
We examine two sources of reporting incentives, contracts that use reported accounting information and transactions with capital markets, and investigate whether the type of reporting incentive impacts the earnings management and disclosure strategies managers employ. The primary difference between contract and market incentives is that the benefits of the former are obtained even if the counter party is aware of (or anticipates) the earnings management. In contrast, a market-motivated strategy can only be successful in the presence of information asymmetry. Consistent with our hypotheses, we find that when the reporting strategy does not require information asymmetry, managers use lower cost earnings management methods and increase disclosure to offset the negative impact of earnings management on financial reporting quality. Thus, this study provides evidence on how managers trade off the incentive to maintain their commitment to a particular level of financial reporting quality with competing incentives that require earnings management.
Keywords: Financial Reporting Quality; Earnings Management; Disclosure; Debt Covenants; Informed Trade
JEL Classification: M41, M42
Suggested Citation: Suggested Citation