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
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: Suggested Citation