Social Ties and Earnings Management

Abstract

We detect a significant presence of social ties between the CEO and audit committee members and our results suggest that these informal ties play a material role in audit-committee oversight. In particular, we find a substantially stronger, positive relation between abnormal (i.e., discretionary) accruals and the extent of an audit committee’s connection to the CEO when we consider social ties in addition to the conventional ties. Moreover, we find that an audit committee’s social affiliation is associated with an increased discontinuity in the earnings distribution surrounding earnings targets. Together, our findings suggest that informal ties play a material role in facilitating creative accounting practices.