Accounting Based Regulation And Earnings Management
Speaker(s) Prof. Radhakrishnan Gopalan, Associate Professor, Olin School of Business, Washington University in St. Louis

We document the distortionary eff ects of accounting-based regulation on reported earnings. In India only fi rms with negative book value of equity (networth) can seek bankruptcy protection. Using a novel dataset of bankrupt firms from India, we show that fi rms manage earnings downward to seek bankruptcy protection. Strengthening creditor rights reduces downward earnings management among non-group affiliated firms. There is also evidence for upward earnings management among fi rms with positive, but low networth in an eff ort to avoid bankruptcy fi ling. Finally, we show that pre-bankruptcy accruals are a strong signal of opportunistic bankruptcy fi ling. Firms with income-decreasing pre-bankruptcy accruals have worse post-bankruptcy performance. Overall, our paper highlights distortions that arise from accounting-based rules and underscores the importance of factoring economic incentives in the design of such regulation.

Download Paper