How Do Natural Disasters Impede Corporate Earnings Management?

Abstract

Natural disasters can cause heavy economic losses to firms, potentially propelling these firms to use earnings management to change public perceptions of 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 publicly listed U.S. 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 14.9% in the two years following such disasters. The negative effect is mediated through the information disclosure channel. Natural disasters have a more pronounced effect on firms in less competitive markets and firms with less tangible assets. 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.

Keywords: natural disasters, earnings management, external monitoring

JEL Classification: G10, G14, Q54