COVID-19, Investor Protection and Earnings Management: A Cross-country Analysis Abstract
The importance of the agency problem in external finance has sparked research on investor protection, and earnings management, in the finance literature. Studies find that investor protection decreases accrual earnings management and increases real earnings management (Enomoto et al., 2015) while institutions impact earnings management strategies during financial crises (Wysocki, 2004; Persakis & Iatridis, 2016). This study combines these perspectives and examines how investor protection influences earnings management during COVID-19. I have two hypotheses; first, the relation between investor protection and accrual earnings management is stronger during COVID-19; second, firms with strong investor protection substitute more real earnings management for accrual earnings management during COVID-19. I proxy investor protection with the clusters of Leuz et al. (2003) and measure accrual earnings management and real earnings management with the Kothari model (Kothari et al., 2005) and the proxies of Roychowdhury (2006), respectively. The final sample includes 4,326 firm-year observations from nine countries. The results do not support the first hypothesis, and counterintuitively I observe a positive relation between investor protection and accrual earnings management contradicting previous literature. Besides, I observe that firms with strong investor protection turn to more real earnings management during COVID-19 supportive of the second hypothesis.
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