Audit Committee Interlocks and the Contagion of Accrual-Based and Real Earnings Management
46 Pages Posted: 10 Feb 2016
Date Written: January 29, 2016
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
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