Earnings Management upon a Sovereign Downgrade

62 Pages Posted: 30 Jan 2020 Last revised: 20 Jul 2021

See all articles by Yupeng Lin

Yupeng Lin

National University of Singapore

Bohui Zhang

The Chinese University of Hong Kong, Shenzhen

Zilong Zhang

City University of Hong Kong

Date Written: July 15, 2020

Abstract

We examine the effect of sovereign credit rating downgrades on firms’ earnings management. Using the exogenous variation in credit ratings caused by sovereign rating downgrades from 61 countries, we show that firms reduce discretionary accruals after sovereign downgrades and are likely to experience a reversal of earnings subsequent to the accrual reduction. The reduction in discretionary accruals is more significant in countries with a better institutional environment and when the sovereign rating falls into a lower bin. Our study provides new evidence that managers strategically employ downward earnings management in response to the negative shock on sovereign credit ratings.

Keywords: Sovereign downgrade, Ceiling rule, Credit rating, Earnings management, Big bath accounting

JEL Classification: G34, G24, M41

Suggested Citation

Lin, Yupeng and Zhang, Bohui and Zhang, Zilong, Earnings Management upon a Sovereign Downgrade (July 15, 2020). Available at SSRN: https://ssrn.com/abstract=3516414 or http://dx.doi.org/10.2139/ssrn.3516414

Yupeng Lin

National University of Singapore ( email )

15 Kent ridge drive
Singapore
Singapore

HOME PAGE: http://sites.google.com/site/scottlinyupeng/

Bohui Zhang

The Chinese University of Hong Kong, Shenzhen ( email )

Zilong Zhang (Contact Author)

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

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