Earnings management in local governments: the role of political factors

Abstract

Purpose The purpose of this paper is to examine earnings management practices in local governments (LGs). The implementation of accrual accounting in LGs opens the way for empirical research on the topic, as reporting high surpluses or high deficits can be negatively interpreted by the central government, monitoring authorities, citizens and political opponents. According to public choice theory, the conflicting interests between politicians, who pursue re-election, and voters, who observe politicians’ actions to assess their alignment with social welfare, create fertile ground for earnings management practices. Design/methodology/approach The study calculates discretionary accruals, by using the Jones (1991) model, and relates them to several political variables. It employs a large sample of Greek and Italian LGs. The Greek database covers the period from 2002 to 2015 with about 4,300 observations, and the Italian database includes the period from 2008 to 2015 with about 1,130 observations. Findings The findings from the analysis give evidence that LGs engage in earnings management. The principal factor is the electoral cycle, as earnings management seems to be greater when the mayor is re-elected than when the mayor is elected for the first time. Furthermore, the period before elections create conditions that cultivate earnings management attitudes. Research limitations/implications Previous studies have principally investigated earnings management in the private sector. Considering that many public-sector entities have implemented accrual accounting systems, this study intends to examine earnings management behaviour at the LG level, providing interesting findings for researchers and policy makers. Practical implications A better understanding of the political factors and the financial conditions, which act as obstacles or facilitators, should work hand in hand with the accounting reforms. The usefulness of financial statements for decision making and control presupposes that they are of high quality, an attribute that can be impaired by earnings management. Originality/value This study investigates the influence of political factors on earnings management behaviour in public-sector contexts where self-interest and accountability pressures coexist.

Public Pension Governance and Opportunistic Accounting Choice: A Politico-Economic Approach

“…Although GASB 68 was implemented a year later than GASB 67, it is reasonable to assume that the perceived utility associated with OPAC decisions made in FY 2013/2014 includes consideration of these changes. This assumption is consistent with earlier research, which indicates that opportunistic accounting choices often are strategic in nature (e.g., Cohen et al, 2019; Donatella, 2020; Ferreira et al, 2013; Stalebrink, 2007).…”

“…Consistent with prior research, we define opportunistic accounting choice as the deliberate use of accounting discretion for purposes of artificially distorting measures of financial performance, including financial position (i.e., financial health) and results (see Healy & Wahlen, 1999). While the large majority of empirical research on this topic has centered on private firms (Dechow et al, 2010; Healy & Wahlen, 1999), several empirical studies have also been produced in public sector contexts (e.g., Arcas & Marti, 2016; Cohen et al, 2019; Donatella, 2020; Ferreira et al, 2013; Greenwood et al, 2017; Stalebrink, 2007). Similar to studies conducted on private firms, these studies have typically relied on an agency or public choice framework, where it is argued that public officials have incentives to use discretion in accounting policy, because it aids them in the pursuit of economic and political goals.…”

“…One repercussion of such constraints is that they hamper the government’s ability to meet balanced budget expectations. Frequent failures to meet these might negatively affect voters’ perceptions about elected officials’ ability to govern (Cohen et al, 2019; Donatella, 2020; Ferreira et al, 2013), thereby reducing chances of re-election, career advancement, and other benefits. By reducing ARC amounts, OPAC can be used to artificially reduce or eliminate a deficit, and thus enhance a government’s ability to meet balanced budget requirements.…”

Earnings management in public-sector organizations: a structured literature review

“…As for articles focused on local governments, it seems that less recent studies (Stalebrink, 2007;Pinnuck and Potter, 2009) aimed to assess the magnitude of EM behavior, while more recent articles mainly studied the determinants of EM, especially focusing on the role of political factors and political competition (e.g. Kido et al, 2012;Ferreira et al, 2013Ferreira et al, , 2020Cohen et al, 2019;Donatella, 2020 Ding et al, 2007;Chen et al, 2011;Capalbo et al, 2014;Liu et al, 2014;Huang and Li, 2016;Wang et al, 2020). It is also worth noting that the vast majority of these articles focused on the Chinese context, and that some additional political factors are at play here that are not found in EM research outside the Asian context (e.g.…”

Earnings management in state-owned enterprises: bringing publicness back in

“…Furthermore, empirical research has often focused on country-specific features or exceptional events in the life of an SOE (Lin et al, 2015 ; Liu & Lu, 2007 ; Wang & Yung, 2011 ). Not least, the relationship between EM and political elections has been also investigated (Capalbo et al, 2020 ; Chen et al, 2008 ; Cohen et al, 2019 ; Repetto, 2015 ).…”