Accounting Standards, Reporting Incentives, and Earnings Management

Abstract

In this study, we examine which factor, firms’ accounting standards or firms’ reporting incentives, has a greater impact on firms’ earnings management behavior. To answer this question, we utilize unique hand-collected data that consists of foreign firms cross-listed in the U.S. using U.S. GAAP. This interesting setting allows us to control for differing accounting standards and external monitoring from the SEC between foreign firms and their U.S. domestic counterparts. Therefore, if there is any observed difference in the level of firms’ earnings management, that difference can be mainly attributed to firms’ reporting incentives rather than firms’ accounting standards. Our findings suggest that cross-listed foreign firms using U.S. GAAP exhibit more accruals-based and real activities earnings management relative to domestic firms. The results suggest that accounting standards, regulations, and enforcement is not enough to eliminate opportunistic reporting behavior. Firm incentives will still impact the magnitude of earnings management. This finding is particularly important given the hot debate regarding whether the U.S should adopt IFRS or not. No matter what accounting standards firms choose, U.S GAAP or IFRS, firms’ earnings quality can still vary with differing reporting incentives.