Political Connections and the Trade-Off between Real and Accrual-Based Earnings Management

Posted: 9 Mar 2023

See all articles by Anwer S. Ahmed

Anwer S. Ahmed

Texas A&M University - Mays Business School

Megan Grady

California State University, Fullerton

Scott Duellman

Saint Louis University - Department of Accounting

Date Written: July 18, 2022

Abstract

We provide evidence on the effect of political connections on the trade-off between real and accrual-based earnings management in the United States. This evidence is important because prior literature documents mixed evidence on whether political connections reduce the threat of SEC enforcement. By studying earnings management with a large sample, our study provides more generalizable insights into the effects of political connections on enforcement. We argue that politically connected firms face a lower threat of enforcement, which reduces the costs of accrual-based earnings management and alters the trade-off between real and accrual-based earnings management. Consistent with our predictions, using a single-step estimation method as well as a difference-in-differences test based on an exogenous shock, we find that connected firms engage in more accrual management and less real earnings management. Our results are driven by firms that have relatively high costs of real earnings management. Furthermore, we find that political connections mitigate the relation between SEC comment letters and earnings management. Overall, the evidence is consistent with politically connected firms facing a lower threat of regulatory enforcement and using this flexibility to increase accrual-based earnings management and reduce real earnings management that is potentially value destructive. Our study complements and strengthens inferences in prior work that documents evidence of lax SEC enforcement for politically connected firms using small samples. Our findings should be of interest to policymakers, regulators, and other professionals that are interested in understanding the effects of political connections.

Keywords: political connections, corporate lobbying, real activities management, earnings management trade-offs

Suggested Citation

Ahmed, Anwer S. and Grady, Megan and Duellman, Scott, Political Connections and the Trade-Off between Real and Accrual-Based Earnings Management (July 18, 2022). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=4170309

Anwer S. Ahmed (Contact Author)

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Megan Grady

California State University, Fullerton ( email )

Fullerton, CA
United States

Scott Duellman

Saint Louis University - Department of Accounting ( email )

3674 Lindell Blvd.
St. Louis, MO 63108
United States

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