Accrual-Based Earnings Management and Regulation: A Literature Review*

Abstract

This paper reviews how the accounting literature has investigated accrual-based earnings management (AEM) in relation to regulation. After describing the development of accrual-based models to measure earnings management, I provide evidence that the accounting literature has investigated AEM and regulation to answer six types of research questions. First, researchers investigate whether firms manage earnings before a regulatory event to benefit from it or to avoid its negative consequences. Second, they look at whether firms engage in AEM after the implementation of a new regulation to avoid the regulatory costs associated with lack of compliance or to respect regulatory industry ratios. Third, researchers use accruals quality metrics to investigate the change in quality of accounting after a change in regulation. Fourth, they use accruals quality metrics to analyze the impact of differences between regulatory environments. Fifth, researchers exploit Accounting and Auditing Enforcement Releases to clearly identify samples of low-quality firms in order to develop new earnings management models, test the specifications of existing models, or identify new patterns linked to earnings management. Sixth, the accounting literature employs regulation to investigate potential complementarity or substitution effects between accrual-based and real earnings management. I also discuss how the emergence of new technologies such as machine learning, the ongoing debate between single-accrual and aggregate models, regulatory events other than laws, and recent regulations create opportunities for future research into AEM in relation to regulation.