The Consolidation Trap : Empirical Evidence from Differences in Earnings Management Incentives and Practices in Brazil

This paper investigates a particular scenario under the Brazilian Generally Accepted Accounting Principles before IFRS adoption, which require public companies to disclose individual financial statements (legal parent entity), together with consolidated financial statements (economic entity). Notwithstanding, different incentives for earnings management can be identified in comparing legal and economic entities and their respective financial statements. We use two models of earnings management, Jones Modified with 848 observations and KS with 694 observations for the same period 2000 to 2006. This research shows certain evidence on income-decreasing expense accounting choices in legal entities financial statements, consistent with the hypothesis of management for lowering tax burden. Whereas, evidence from economic entity (consolidate accounting figures) suggests income-increasing accounting choices, consistent with the political cost and capital market pressure hypotheses. These results can contributes to understand the real impact of legal system in firms accounting in Brazil, since the disclosure requirement for individual and consolidated financial statements is mandatory for few countries around the world