The spillover effect of penalty against peer firm leaders——Evidence from earnings management

Abstract

This paper investigates whether and how the penalty against peer firm leaders influences focal firm's earnings management. By employing a difference-in-difference (DID) approach, we find that penalties on peer firm leaders significantly decrease focal firms’ earnings management, suggesting that firms adjust their expected costs related to misconducts when observing the salient penalties against their peers. Further analyses document that this effect is significantly stronger for firms that have witnessed severer penalties, firms with better corporate governance, and firms located in provinces with stronger law enforcement. Moreover, we find such peer firm penalties mainly decrease focal firms’ upward earnings management rather than downward earnings management.