Political Connections and the Tradeoff between Real and Accrual-based Earnings Management

45 Pages Posted: 26 Jul 2018 Last revised: 10 Jul 2022

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Scott Duellman

Saint Louis University - Department of Accounting

Megan Grady

California State University, Fullerton

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

Ahmed, Anwer S. and Duellman, Scott and Grady, Megan, Political Connections and the Tradeoff between Real and Accrual-based Earnings Management (July 8, 2022). Mays Business School Research Paper No. 3219428, Available at SSRN: https://ssrn.com/abstract=3219428 or http://dx.doi.org/10.2139/ssrn.3219428

Anwer S. Ahmed

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Scott Duellman

Saint Louis University - Department of Accounting ( email )

3674 Lindell Blvd.
St. Louis, MO 63108
United States

Megan Grady (Contact Author)

California State University, Fullerton ( email )

Fullerton, CA
United States

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