Natural Disasters Impede Corporate Earnings Management
29 Pages Posted: 7 Oct 2020 Last revised: 16 May 2022
Date Written: May 14, 2022
Natural disasters cause heavy economic losses to firms, potentially propelling these firms to use earnings management to change public perceptions on the damage. However, no academic consensus has been reached on how and when firms manage earnings following external shocks. In this study, we use difference-in-difference regressions for a sample of U.S. publicly listed firms from 1980 to 2017 to investigate the effects of natural disasters on the timing and magnitude of earnings management. We find that natural disasters reduce the magnitude of corporate earnings management by 16.08% in the two years following such disasters. This negative effect is mediated through the information disclosure channel. The breakdown into five specific types of natural disasters shows that such effect is most pronounced for wildfires. Natural disasters have a more pronounced effect on firms in a less competitive market and firms with lower asset tangibility. Our results are robust to several alternative earnings management measures and a placebo test. Our findings of reduced earnings management following negative external shocks are contradictory to big bath accounting practices, but are consistent with the rational expectations of executives and the external monitoring of stakeholders. We propose policy recommendations for improving information disclosure quality and alleviating earnings management following external shocks.
Keywords: natural disasters, earnings management, external monitoring
JEL Classification: G10, G14, Q54
Suggested Citation: Suggested Citation