Product Market Competition and Earnings Management: Some International Evidence

Abstract A long standing question is whether product market competition disciplines a firm’s incentive to engage in earnings management. This paper argues that this question cannot be investigated adequately without accounting for the quality of firms’ auditors, because auditors affect the probability of discovering earnings management. Since firms choose their auditor, a non-compliant firm can alter its own probability of being detected. Consequently, a firm’s decision to manage earnings is a function of its auditor’s quality, which is itself endogenously chosen by the firm. To study this issue we develop a game-theoretic model that captures the potential inter-relationship between industry competition, the firms’ choice of audit quality, and compliance with accounting regulations (or the degree of earnings manipulation). We show that the link between financial compliance and product market competition is affected by the endogenously chosen audit quality. We estimate this model’s structural parameters and find that greater competition reduces both compliance and the demand for high quality audits.

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Product Market Competition, Ownership Differences, and Earnings Management: Evidence from Chinese Listed Companies

Proceedings of the International Conference on Logistics, Engineering, Management and Computer Science ◽

10.2991/lemcs-15.2015.287 ◽

2015 ◽

Author(s):

Lihui Yu ◽

Yanhua Wen

Keyword(s):

Earnings Management ◽

Market Competition ◽

Product Market ◽

Listed Companies ◽

Product Market Competition ◽

Chinese Listed Companies

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Oligopoly, Disclosure, and Earnings Management

The Accounting Review ◽

10.2308/accr.2010.85.4.1191 ◽

2010 ◽

Vol 85 (4) ◽

pp. 1191-1214 ◽

Cited By ~ 61

Author(s):

Mark Bagnoli ◽

Susan G. Watts

Keyword(s):

Earnings Management ◽

Lower Cost ◽

Market Competition ◽

Product Market ◽

Industry Structure ◽

Information Environment ◽

Product Market Competition ◽

Total Production ◽

Product Price ◽

Financial Reports

ABSTRACT: We examine how biased financial reports (managed earnings) affect product market competition and how product market competition affects incentives to bias financial reports in a model with fully rational firms. We find that Cournot competitors bias their reports to create the impression that their costs are lower than they actually are. This bias leads to lower total production and a higher product price, even though each firm fully understands its rival’s incentives to bias its financial reports. The magnitude of the bias is larger when firms compete in more profitable product markets and smaller when the firm can extract more information about its rival’s costs from its own. When the costs of misreporting are asymmetric, the lower-cost firm engages in more earnings management than its rival, produces more than it would in a full-information environment, and earns greater profits. Our analysis leads to new, testable relations among earnings management, reported and actual earnings, and industry structure.

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