Local Governments’ Earnings Management: Greek and Italian Evidence

Abstract

The paper aims to examine earnings management practices in local governments, focusing on two Mediterranean countries, namely Greece and Italy that have comparable administration systems. According to public choice theory, the conflicting interests between politicians who pursue re-election and voters who monitor politicians’ actions to assess their alignment with social welfare create fertile ground for earnings management practices. A large sample of Greek and Italian local governments (LGs) is analysed; the study calculates discretionary accruals, using the Jones (1991) model, and relates them to several political variables. The Greek database covers the period from 2002 to 2015 with about 4,300 observations, and the Italian database includes the period from 2008 to 2015 with about 1,130 observations. The findings from the analysis evidence that LGs engage in earnings management, the principal factor being the electoral cycle, especially in the case of Greek municipalities. Considering that many public-sector entities have implemented accrual accounting systems, this study intends to examine earnings management behavior at the local government level, providing interesting findings for researchers and policymakers. A better understanding of the political factors and the financial conditions, which act as obstacles or facilitators, should work hand in hand with the accounting reforms. The usefulness of financial statements for decision making and control presupposes that they are of high quality, an attribute that can be impaired by earnings management. To the best of our knowledge, this is the first study to investigate earnings management behavior in different public-sector settings.