Firm Rigidities and Earnings Management

This study investigates the relationship between firm rigidity and earnings management. Firm rigidity is conceptualized along two dimensions—rigid cost structures and inflexible investment policies—that restrict firms’ capacity to adapt to changing business conditions or emerging investment opportunities. Using a sample of U.S. publicly listed firms spanning 1991 2022 from the WRDS databases, this paper examines whether firms with greater rigidity exhibit higher levels of earnings management than their more flexible counterparts. After controlling firm-specific characteristics and incorporating year and industry fixed effects, the paper finds that both cost rigidity and investment rigidity are positively and significantly related to earnings management. These findings are robust to the alternative measure of earnings management and different model specifications. Overall, the results indicate that structural rigidities limit firms’ real operational adjustments and increase their reliance on discretionary financial reporting. Journal: Journal of Finance and Accountancy, Volume 35. Authors: Qian (Susan) Sun and Md Asif ul Alam