Abstract

Most scholars have indicated corporations using accounting conservatism to reduce earnings manipulation, although certain scholars believe that firms have more incentive to increase earnings manipulation. Institutional investors play an important external monitoring role, and affect firm’s earnings manipulation. Previous studies adopted accruals as an earnings manipulation proxy to detect the relationship among accounting conservatism, institutional investor shareholdings, and earnings manipulation. We further investigate the relationship among accounting conservatism, institutional investor shareholdings, and earnings manipulation by using Benford’s law. Our results indicate that firms with more conservative financial reporting have less probability of engaging in earnings-manipulative activities. We also find the negative association between earnings management and institutional investor shareholdings. However, if corporate financial statements tend toward conservatism, institutional investor shareholdings could increase managers’ incentive to manage earnings. Our findings have important implications for investors to make investment decisions.

Introduction

Earnings management increases outsider uncertainty and potentially leads to information asymmetries among firm managers, resulting in decreasing investment efficiency. In prior studies, accounting conservatism was shown to reduce the adverse effects of existing information asymmetry between outside investors and managers by restricting managerial accounting manipulation (LaFond and Watts, 2008). Accounting conservatism is a measure to limit the amount of financial statement risk. This study introduced a measure to examine the association between accounting conservatism and earnings management, and determine whether accounting conservatism reduces earnings management in the enterprise.