Political Corruption and Accounting Choices

Using U.S. Department of Justice data on political corruption convictions, I examine how political corruption affects firms’ earnings management. I find that companies headquartered in more corrupt states manipulate earnings downwards. The findings are robust to six alternative corruption measures, the restatement analysis, the accounting policy analysis, the instrumental variable approach, the difference-in-differences analysis, and an event study. In addition, I find that the effect of corruption on earnings management is more pronounced for firms whose operations concentrate in their headquarter states and for firms without political connections, but is not significant for firms on the edge of missing earnings benchmarks or firms facing tight debt covenants. In sum, my findings suggest that firms respond to corruption by managing earnings downwards.