Product market competition and earnings management: the role of managerial ability

Abstract

Purpose This study aims to examine whether and how managerial ability is associated with the relation between product market competition and earnings management. The authors argue that high-ability managers may moderate the underlying relations in both directions, and they are likely to trade off relative costs between accrual-based earnings management (AEM) and real earnings management (REM). Design/methodology/approach This study uses ordinary least square regressions to examine the association of managerial ability on the relations between product market competition and earnings management. The paper follows prior literature to measure managerial ability, product market competition and earnings management. Findings This study shows empirical evidence that high-ability managers in high-competition industries are likely to engage in AEM but less likely to engage in REM. These findings overall indicate that high-ability managers in high-competition industries trade-off between different forms of earnings management based on their relative costliness and choose the one that is relatively less costly. Practical implications This study has important practical implications as the findings identify situations when important stakeholders, such as the board of directors and investors, may take precautions to prevent managers’ opportunistic behaviors. The findings of this study also might be helpful for firms when it comes to selecting managers. The findings may provide some input to the firms in considering the risks and benefits trade-offs of recruiting a high versus low-ability manager in a more or less competitive environment. Originality/value The findings of this study show new insight into how managerial ability moderates the relation between product market competition and different types (i.e. accrual-based and real activity-based) of earnings management.