Earnings Management to Avoid Additional Disclosures : Evidence from Germany

This paper takes advantage of a regulation in Europe that allows member states to prescribe lighter reporting requirements for smaller unlisted firms. Under this framework firm size is measured using three variables – total assets, revenues, and number of employees – over which firms have ultimate discretion. Depending on the realization of these variables firms are categorized as small, medium or large, coming along with different mandatory disclosure levels. However, a reclassification only takes place if two out of the three thresholds are met in two consecutive years. Since an increased disclosure level may not be optimal for all firms (e.g. due to dissemination of proprietary information), it is likely to observe firms impeding a reclassification. Our evidence suggests that some firms indeed manage the relevant indicators to obfuscate that they should be classified as larger entities. This conclusion is based on a thorough analysis of reporting anomalies in the period in which otherwise a reclassification would occur: We employ discontinuity analyses (box plots, unexpected growth in size indicators) and discretionary accruals models (modified cross-sectional Jones Model and accrual quality model by Dechov and Dichev, 2002). We also perform an analysis of real earnings management (Roychowdhury, 2006) and run several robustness checks