Wrongful Discharge Laws and Real Earnings Management

• In Event: Real Earnings Management and The Cost of Misreporting

Abstract

In this paper we examine whether wrongful discharge laws enhance the governance role played by firm employees in constraining real earnings management. By protecting employees from unjust dismissal, wrongful discharge laws increase employees’ bargaining power and career horizon, which motivate them to safeguard long-run firm value. We exploit exogenous staggered changes in wrongful discharge laws across the U.S. states and find a reduction in real earnings management following the passage of wrongful discharge laws. Consistent with the employee monitoring hypothesis, cross-sectional analysis shows that the impact of wrongful discharge laws varies with employees’ ability and incentives to intervene in real earnings management.

Authors

• Kelly Huang, Florida International University

• Brent Lao, Florida International University