Audit Committee Interlocks and the Contagion of Accrual-Based and Real Earnings Management

46 Pages Posted: 10 Feb 2016

See all articles by Ravi Dharwadkar

Ravi Dharwadkar

Syracuse University - Whitman School of Management

David G. Harris

Syracuse University - Joseph I. Lubin School of Accounting

Linna Shi

University of Cincinnati - Department of Accounting

Nan Zhou

University of Cincinnati - Lindner College of Business

Date Written: January 29, 2016

Abstract

Cohen et al. (2008) document that firms switched from accrual-based earnings management (AEM) to real earnings management (REM) within three years after passage of the Sarbanes-Oxley Act (SOX) in 2002. A remaining question is how so many firms could have made the transition from one accounting practice to another in such a short period of time. We investigate a hidden mechanism underlying this large-scale, accelerated transfer of accounting knowledge. Our study reveals that audit committee interlocks facilitated firms’ post-SOX substitution from AEM to REM, contributed to the contagion of AEM before SOX and to the contagion of REM after SOX. Our results are robust for subsamples of intangible-intensive firms and manufacturing firms, which are more susceptible to REM. We further create a REM-AEM substitution index and find that the contagion of substitution from AEM to REM was disseminated through audit committee interlocks. Overall, we identify audit committee interlocks as a significant channel for transmitting accounting information between firms.

Keywords: audit committee interlock, contagion effect, real earnings management, accrual-based earnings management, information transfer

JEL Classification: M42, M41, G34, D83

Suggested Citation

Dharwadkar, Ravi and Harris, David G. and Shi, Linna and Zhou, Nan, Audit Committee Interlocks and the Contagion of Accrual-Based and Real Earnings Management (January 29, 2016). Available at SSRN: https://ssrn.com/abstract=2729855 or http://dx.doi.org/10.2139/ssrn.2729855

Ravi Dharwadkar

Syracuse University - Whitman School of Management ( email )

721 University Avenue
Syracuse, NY 13244-2130
United States

David G. Harris

Syracuse University - Joseph I. Lubin School of Accounting ( email )

Whitman School of Management
721 University Ave
Syracuse, NY 13244-2130
United States
315-443-3362 (Phone)
315-443-5457 (Fax)

Linna Shi (Contact Author)

University of Cincinnati - Department of Accounting ( email )

Cincinnati, OH 45221-0211
United States
(513) 556-2097 (Phone)

Nan Zhou

University of Cincinnati - Lindner College of Business ( email )

P.O. Box 210211
Cincinnati, OH 45221-0211
United States

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