The Effects of Corruption Investigations on Real Earnings Management: The Contagion Effect

56 Pages Posted: 6 Jan 2021 Last revised: 26 Mar 2021

Date Written: March 25, 2021

Abstract

In 2014, Brazil’s Federal Police launched an investigation (‘Car Wash’) on the country’s largest state-controlled companies, exposing a kickback scheme related to overpriced contracts. The alleged corruption required these companies to engage in real earnings management (REM) to hide the excessive costs of these contracts. We predict and find that these companies reduced their REM activities after the investigation’s launch, confirming prior study’s findings that companies under investigation curb their REM activities. Our contribution lies in examining whether the investigation also resulted in a reduction in REM for companies facing similar public scrutiny (a contagion effect). We find evidence of the contagion effect with other large state-owned companies as well as with other large publicly-scrutinized companies, in line with Positive Accounting Theory. The results of our study suggest that such investigations are effective in not only enforcing corruption statutes on those investigated, but also effective in deterring corruption.

Keywords: Real earnings management, Contagion effect, Corruption investigations

Suggested Citation

Da Silva Junior, Dirlei Luis and De Moura, André Aroldo Freitas and Tiras, Samuel L., The Effects of Corruption Investigations on Real Earnings Management: The Contagion Effect (March 25, 2021). Available at SSRN: https://ssrn.com/abstract=3739126 or http://dx.doi.org/10.2139/ssrn.3739126

Dirlei Luis Da Silva Junior

TAESA ( email )

Praça XV de Novembro 20
Rio de Janeiro, 20010-010
Brazil
+55 (21) 97612-6743 (Phone)

André Aroldo Freitas De Moura

FUCAPE Business School ( email )

Fernando Ferrari Avenue, 1358
Goiabeiras
Vitória, Espirtio Santo 29075-010
Brazil

Samuel L. Tiras (Contact Author)

Indiana University - Kelley School of Business ( email )

801 W. Michigan Street
Indianapolis, IN 46202
United States
(317) 274-3420 (Phone)

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