The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms

Posted: 23 Mar 2006 Last revised: 20 Nov 2011

See all articles by David Burgstahler

David Burgstahler

University of Washington

Luzi Hail

University of Pennsylvania - The Wharton School; European Corporate Governance Institute (ECGI)

Christian Leuz

University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Leibniz Institute SAFE; CESifo Research Network; Center for Financial Studies (CFS)

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Abstract

This paper examines how capital market pressures and institutional factors shape firms' incentives to report earnings that reflect economic performance. To isolate the effects of reporting incentives, we exploit the fact that, within the European Union, privately held corporations face the same accounting standards as publicly traded companies because accounting regulation is based on legal form. We focus on the level of earnings management as one dimension of accounting quality that is particularly responsive to firms' reporting incentives. We document that private firms exhibit higher levels of earnings management and that strong legal systems are associated with less earnings management in private and public firms. We also provide evidence that private and public firms respond differentially to institutional factors, such as book-tax alignment, outside investor protection and capital market structure. Moreover, legal institutions and capital market forces often appear to reinforce each other.

Keywords: international accounting, earnings management, private companies, legal system, accounting harmonization, earnings properties

JEL Classification: G14, G15, G30, G32, K22, M41, M43, M47

Suggested Citation

Burgstahler, David C. and Hail, Luzi and Leuz, Christian, The Importance of Reporting Incentives: Earnings Management in European Private and Public Firms. Accounting Review, Vol. 81, No. 5, pp. 983-1016, 2006, Available at SSRN: https://ssrn.com/abstract=890648

David C. Burgstahler

University of Washington ( email )

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Luzi Hail (Contact Author)

University of Pennsylvania - The Wharton School ( email )

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European Corporate Governance Institute (ECGI) ( email )

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Christian Leuz

University of Chicago - Booth School of Business ( email )

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HOME PAGE: http://faculty.chicagobooth.edu/christian.leuz/

National Bureau of Economic Research (NBER) ( email )

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Centre for Economic Policy Research (CEPR) ( email )

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Leibniz Institute SAFE ( email )

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CESifo Research Network

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