Product Market Competition and Earnings Management: Some International Evidence

Abstract

We provide international evidence that industries with increased intensity of import penetration and lower price-cost margins induce insiders of firms in these industries to more aggressively manage earnings. We interpret this result to be consistent with the explanation that competition reduces the firm’s profitability and the aggressive earnings management may stem from managerial desire to distort true economic performance. Doing so enables the manager to protect a portion of his or her private control benefits. To confirm the plausibility of this explanation, we correlate our earnings management proxies with a widely used measure of private benefits i.e. the voting premium between shares with differential voting rights. We find a strong positive correlation between the voting premium and our earnings management proxies. This helps us strengthen the likelihood of the private benefits hypothesis relative to other alternative explanations. We also confirm the findings of prior research that competition mitigates managerial private benefits of control. However, this effect is found to be less pronounced in firms that aggressively manage earnings. We interpret this result to be consistent with the possibility of competition to more likely reveal inefficiencies or funds diversion in low earnings management firms relative to high earnings management firms. JEL Classification: F30; G30; G15; M41. 1 Corresponding author: 315 Gerson Hall, P. O. Box 117166, Gainesville, FL 32611-7166. Tel: 352-273-0211. Fax: 352-273-0200. Email: surjit.tinaikar@cba.ufl.edu. We thank Craig Doidge for facilitating access to his database on international dual class share firms.