Earnings Management and Investor Protection: An International Comparison

Abstract

This paper examines the pervasiveness of earnings management across 31 countries between 1990 and 1999. It documents systematic differences in earnings management across different clusters of countries. We propose an explanation for these differences based on the notion that insiders, in an attempt to protect their private control benefits, use earnings management to conceal firm performance from outsiders. Thus, earnings management is expected to decrease in investor protection because strong protection limits insiders' ability to acquire private control benefits, which reduces their incentives to mask firm performance. Our evidence is consistent with this prediction. The findings suggest a link between corporate governance and the quality of reported earnings, and complement prior finance research that treats the quality of corporate reporting as exogenous.

Keywords: Corporate Governance, Earnings Management, Investor Protection, Law, Private Control Benefits

JEL Classification: G34, G38, M41