This paper provides comparative evidence on corporate earnings management across 31 countries. At a descriptive level, we find large international differences across several earnings management measures, including loss avoidance and earnings smoothing. Our descriptive evidence suggests that firms in countries with developed equity markets, dispersed ownership structures, strong investor rights, and legal enforcement engage in less earnings management. We then delve deeper and present an incentives-based explanation for these patterns.

Based on prior research that identifies investor protection as a key institutional factor affecting corporate policy choices (see Shleifer and Vishny, 1997; La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 2000), we focus on investor protection as a significant determinant of earnings management activity around the world. We argue that strong and well-enforced outsider rights limit insiders’ acquisition of private control benefits, and consequently, mitigate insiders’ incentives to manage accounting earnings because they have little to conceal from outsiders. This insight suggests that the pervasiveness of earnings management is increasing in private control benefits and decreasing in outside investor protection. Our empirical results are consistent with this prediction and suggest that investor protection plays an important role in influencing international differences in corporate earnings management.