Political Corruption and Accounting Choices

Abstract

We examine how political corruption affects firms’ accounting choices. We hypothesize and find that firms headquartered in corrupt districts manipulate earnings downwards, relative to firms headquartered elsewhere. Our finding is robust to alternative corruption measures, restatement-based earnings management measures, and the instrumental variable approach. Consistent with the motive to depress earnings, we find that firms headquartered in corrupt districts prefer LIFO over FIFO, and the accelerated depreciation method over the straight-line method, they report high LIFO reserve and depreciation reserve, and they tend to select a low useful life estimate. Finally, we find that the effect of corruption on earnings management is more pronounced for geographically concentrated firms and for firms without political connections. In sum, our findings suggest that firms respond to corruption by lowering their accounting earnings.