Looking your Worst: Downward Earnings Management after Activist Challenges

Abstract

Prior work suggests that firms targeted by contentious activist challenges respond with impression management, promoting positive images of their social performance to maintain audience support. In this paper, we propose that targeted firms face simultaneous incentives to downwardly manage audience members’ impression of their economic performance through negative earnings management. We draw on work in accounting, law, and sociology that suggests that profitability operates as an aggravating cue in punitive assessments and can augment the likelihood of expensive regulatory interventions during periods of political uncertainty. Accordingly, we suggest that firms are motivated to manage their earnings downward when facing contentious challenges. We test this through a longitudinal analysis of firms’ discretionary accruals-based earnings management over the decade spanning 1997-2007. In line with our theory, we find that contentious challenges are associated with significant down-ward adjusted earnings management, and that this is moderated by factors indicating a firm’s general level of non-market risk, including its reputation, the level of political attention directed to it, and regulators’ capacity for monitoring its financial statements.

Keywords: earnings management, social movements, impression management, reputation, non-market strategy