Languages and Earnings Management

Abstract

We predict that managers of firms in countries where languages do not require speakers to grammatically mark future events perceive future consequences of earnings management to be more imminent, and therefore, they are less likely to engage in earnings management. Using data from 38 countries where languages differ on how they encode time, we find that accrual-based earnings management and real earnings management are less prevalent where there is weaker time disassociation in the language. Our analysis based on the birthplace information of U.S. firms’ CEOs confirms the relation between languages and earnings management. Our study is the first to examine the relation between the grammatical structure of languages and financial reporting characteristics, and it extends the literature on the effect of informal institutions on corporate actions.