Elections and earnings management: evidence from municipally-owned entities

Abstract

This paper extends the understanding of the relationship between accounting and the political process beyond the political cost hypothesis, documenting the fact that a positive relationship exists between elections and earnings management in Municipally-Owned Entities (MOEs). While State ownership is normally believed to be negatively related to earnings management, we document that, during an election period, the political links it creates increase political costs to such a level that this relation is inverted. We perform our analysis using a sample of 3557 Italian utility entities including 506 entities for which one single municipality has the absolute majority of shares. The sample spans a 6-year period including, on average, two election dates for each entity. Our empirical results support the existence of a relationship between elections and earnings management of MOEs and they confirm the intuition of Ramanna and Roychowdhury (J Account Res 48: 445–475, 2010) on the existence of a relationship between political connectedness and pre-electoral earnings management. We corroborate our main results using earnings variation frequency distribution analysis to check whether there is a tendency to adjust the published results upwards. Our results illustrate that, during election periods, MOEs are more likely to publish an increase in their income. While recognising the possibility that politicians might also benefit from the pre-electoral MOE earnings management detected, our paper does not attempt to prove their involvement in the EM activity, so the possibility that a “political State-Owned Entities Earnings cycle” exists is an avenue for further research.