Foreign capital exposure and firms’ financial reporting behavior: international evidence from equity market openings

Abstract

When equity markets open to foreign investors, firms in these markets have significant opportunities for attracting foreign capital. Using a set of economies that opened their equity markets, I find a significant degree of income-increasing earnings management in the year of opening. This positive effect is more pronounced in industries that are more dependent on external financing and for financially constrained firms, suggesting that firms’ need for equity finance contributes the earnings management. The effect is weaker when a firm is constrained from earnings management by a Big N auditor and by being in an economy with stronger legal enforcement. Overall, my results suggest that equity market liberalization fosters firms’ upward earnings management behaviors around the world.