Earnings Management to Attract Foreign Capital: International Evidence from Equity Market Openings
64 Pages Posted: 30 May 2019 Last revised: 26 May 2020
Date Written: May 23, 2020
When equity markets open to foreign investors, firms in these markets face significant opportunities to attract foreign capital. Using a set of countries that opened their equity markets, we find significant income-increasing earnings management in the year of opening, with substantial heterogeneity across industries and firms. The positive effect is more pronounced in industries that are more dependent on external financing and for financially constrained firms, suggesting that firms’ intrinsic need for equity finance contributes to income-increasing earnings management behaviors. The effect is weaker when the firm is audited by a Big N auditor, consistent with the monitoring effect of relatively more reputable auditors. We find that income-increasing earnings management is less pronounced in countries with stronger legal enforcement. Overall, our results suggest that incentives to attract financing when a country opens its equity market to foreign investors affects firms’ reporting bias.
Keywords: equity market opening, earnings management, equity finance dependence
JEL Classification: G15, G18, M41, M43
Suggested Citation: Suggested Citation