Institutional and Structural Constraints to Detecting Earnings Management of Firms Subjected to Price Regulation

Abstract

This study examines the political costs of firms upon the establishment of the Prices Surveillance Authority in Australia in 1984. The paper identifies and defines a linkage between political actions likely to transfer wealth away from targeted firms and firms' subsequent earnings management. The cross-sectional and longitudinal evidence presented in this study does not support the hypothesis that firms are more likely to affect negative accounting accruals during periods when they are subjected to intense political scrutiny as a means of reducing their exposure to political costs. A further examination of the institutional environment and structural arrangements for price surveillance suggests that while establishing a linkage between political costs and earnings management by firms is a necessary condition, it is not by itself a sufficient condition. Earnings management is but one of several options which can be used to deflect political costs by firm managers.