External Monitoring Mechanisms and Earnings Management Using Classification Shifting

• In Event: Financial Accounting and Reporting I

Abstract

This study examines whether managers resort to the classification shifting when their ability to manipulate earnings, using accruals management and real activity management, is constrained by external monitoring mechanisms. Using three external monitoring factors—audit quality, analyst following and institutional ownership—we find that managers are more likely to use classification shifting when the level or quality of external monitoring increases. While the existing academic studies focus on the monitoring effectiveness of auditors, analysts and institutional investors on curbing accrual-based earnings management and real earnings management, this study suggests that these external governance mechanisms may have unintended consequences of promoting another kind of earnings management.

Authors

• Abhijit Barua, Florida International University

• Fang Zhao, Florida International University