An Analysis of Earnings Management by European Private Firms

Abstract

This paper investigates the prevalence of earnings management by private firms in eight European countries with different institutional backgrounds. We explore the distributional properties of earnings levels and earnings changes to compare loss avoidance and earnings decrease avoidance across countries. The empirical evidence suggests that in absence of capital market pressures, firms still have incentives to manage earnings. We find that private firms avoid reporting small losses, and that private firms in countries with high financial and tax accounting alignment manage earnings to reduce taxes. Our results also suggest that some types of earnings management are due to capital market pressures and specific to public firms, since we do not find evidence that private firms avoid earnings decreases.

Keywords: earnings management, loss avoidance, tax management, privately-held firms

JEL Classification: M41, M43, M47, H25