Do changes in accounting discretion affect earnings management? International evidence

Purpose: This study analyzes how variation in accounting discretion due to the adoption of the International Financial Reporting Standards (IFRS) affects the relationship between accrual-based earnings management (AEM) and real earnings management (REM). Methodology or Method: We build on Bae et al. (2008) to measure the Index of accounting discretion (IAD). Using a first-difference estimator and difference-in-differences (DiD) models and paired samples, we investigate how changes in accounting discretion affect earnings management in 43 countries in 2003–2007. Results or Discussion: Most related literature documents a trade-off between AEM and REM. Our study extends this literature by building an IAD and exploring how changes in the provision of accounting discretion affect earnings management. Our results show that increases in IAD positively (negatively) affect accrual-based earnings management (real earnings management). Therefore, providing accounting discretion encourages managers to change accruals and discourages them from changing real decisions for reporting purposes. Contributions: We argue and show that understanding country-level variability in accounting discretion is crucial to understanding managers' overall discretion. Therefore, our article shows that accounting discretion is an important input of overall managerial discretion. We contribute to the literature by creating and providing an objective measure of accounting discretion (i.e., IAD) that focuses on the changes in discretion that managers have between the years before and after the IFRS adoption. This approach allows us to explore the heterogeneity of these changes at the country level due to IFRS adoption. We provide regulators with information to assess the desired and undesired consequences of the global harmonization of accounting rules and the country-level differences in IFRS effects on managerial decisions.