Managers’ rank & file employee coordination costs and real activities manipulation

Abstract

We investigate the effect of managers' rank & file employee coordination costs on real activities manipulation (RAM). We identify exogenous variation in managers' rank & file employee coordination costs using the adoption of 99 wrongful dismissal laws across 47 U.S. states between 1970 and 1999. We first find that RAM declines when managers' rank & file employee coordination costs increase. We further document that managers’ rank & file employee coordination costs reduce decentralized RAM but affect neither centralized RAM nor centralized accrual-based earnings management, both of which are less likely to require rank & file employee coordination. Event-time tests corroborate and document the validity of the parallel trends assumption in our setting. Cross-sectional tests document predictable variation in our main result across firms and over time. Consistent with rank & file employee coordination costs constraining RAM, managers miss earnings thresholds more often after rank & file employee coordination costs increase. Our nuanced inferences inform the literature investigating factors that constrain RAM and the extent to which rank & file employees determine firm outcomes.