Political Connections and the Tradeoff between Real and Accrual-based Earnings Management
45 Pages Posted: 26 Jul 2018 Last revised: 10 Jul 2022
Date Written: July 8, 2022
Abstract
We provide evidence on the effect of political connections on the tradeoff between real and accrual-based earnings management in the US. We argue that politically connected firms face a lower threat of enforcement which reduces the costs of accrual-based earnings management and alters the tradeoff between real and accrual-based earnings management. Consistent with this argument, using a single-step estimation method as well as a difference-in-differences test based on an exogenous shock, we find that connected firms engage in more accrual management and less real earnings management. Our results are driven by firms that have relatively high costs of real earnings management. Furthermore, we find that political connections mitigate the relation between SEC comment letters and earnings management. Overall, the evidence is consistent with politically connected firms facing a lower threat of regulatory enforcement and using this flexibility to increase accrual-based earnings management and reduce real earnings management that is potentially value destructive.
Keywords: Political connections; corporate lobbying; real activities management; tradeoff between real and accrual-based earnings management
JEL Classification: D72, M41, M48
Suggested Citation: Suggested Citation