Interesting new paper. Lail, Bradley E., Martin, Gregory W. and Thomas, Wayne B., The Influence of Strong Shareholders on Earnings Management (December 5, 2012). Available at SSRN: http://ssrn.com/abstract=2185448
Abstract: We examine whether shareholder rights impact the use of accruals to manage earnings. Presumably, shareholder rights aim to better align the actions of managers with the interests of shareholders; however, it is not clear whether such alignment mitigates or exacerbates managers’ propensity to manage earnings. Using a model recently developed by Dechow, Hutton, Kim and Sloan (2012), we document that when shareholder rights are stronger, managers are more likely to (1) manage earnings upward when meeting or slightly beating analyst expectations and (2) manage earnings downward when easily beating analyst expectations. Additional tests confirm that the propensity to manage accruals downward allows managers to reserve current accruals to meet expectations in future periods. Overall, the results are not consistent with the traditional expectation that shareholder rights serve a governance role by reducing discretionary reporting behavior. Given recent demands to enhance shareholder rights, our study highlights an interesting financial reporting consequence.