Earnings management contagion: evidence from institutional equivalence

Abstract

PurposeThe study aims to investigate how the presence and absence of institutional equivalents (interaction of industry peers and local peers) affect the earnings management practices of firms.Design/methodology/approachThe study uses discretionary accruals to operationalize earnings management. A sample of 18,744 Bombay Stock Exchange (BSE) listed firm years spanning over 12 financial years (March 2010–March 2021) has been considered and analyzed through panel data regression models.FindingsThe author’s results show that the earnings management practices of a firm's institutional equivalents and the firm's own earnings management are positively associated, implying that firms closely follow their institutional equivalents. This association is found to be more pronounced among focal firms when the difference between the earnings management levels of industry peers and local peers is greater. Further, the author find that large firms aggressively imitate their industry peers and local peers, whereas profitability does not influence their imitation behavior.Practical implicationsThe author’s findings have implications for understanding peer imitation processes, particularly when firms face increasingly multifaceted institutional environments. It suggests auditors and analysts take into account the earnings management practices of local and industry peers while analyzing the client's financial statements and making forecasts, respectively.Originality/valueThe study is among the pioneering attempts to explore the domain of earnings management from the lens of institutional equivalence and provides compelling evidence that the interaction of industry peers and local peers impacts the earnings management practices of firms.