The purpose of this paper is to explain an economic incentive to manage earnings derived from the intersection of disclosure theory and equity theory and to discuss its behavioral implications.
This is a theoretical paper.
A taxonomy of possible managerial reactions to increased disclosure regulation shows that deception (e.g. earnings management) bears relatively low‐situational‐ethics and high‐situational‐risk.
The taxonomy suggests that deceptive behavior would be better explained by broadening the traditional agency model with a situational ethics component and by relaxing its risk‐aversion assumption.
Theoretical findings suggest that the implementation of additional mandatory disclosure is not an appropriate strategy to limit earnings management in a context where the production of information is implicitly costly for managers, and where information asymmetry exists between managers and investors. However, regulations that raise managers’ awareness regarding personal risks involved with earnings management, such as the Sarbanes‐Oxley Act, appear likely to reduce the prevalence of earnings management.
This paper is one of the first to focus on economic incentives, ethical considerations, and personal risk considerations simultaneously.
