The Influence of Strong Shareholders on Earnings Management

Presumably, shareholder rights aim to better align the actions of managers with the interests of shareholders; however, it is not clear from prior research whether such alignment mitigates or exacerbates managers' propensity to manage earnings. We document that when shareholder rights are stronger, managers are more likely to manage earnings upward to meet analyst expectations or last year's EPS. The greater propensity of firms with strong shareholder rights to manage earnings to meet earnings benchmarks is not consistent with the traditional expectation that shareholder rights serve as a governance mechanism to reduce what could be opportunistic reporting behavior. We further highlight the unique impact of shareholder rights for our sample by demonstrating that other traditional governance mechanisms (audit quality, institutional ownership, and board's financial expertise) have the expected effect of reducing earnings management. Given recent demands to enhance shareholder rights, our study highlights an interesting and perhaps unexpected financial reporting consequence