Market competition, earnings management, and persistence in accounting profitability around the world

Abstract

We examine how cross-country differences in product, capital, and labor market competition, as well as earnings management affect mean reversion in accounting return on assets. Using a sample of 48,465 unique firms from 49 countries, we find that accounting returns mean revert faster in countries where there is more product and capital market competition, as predicted by economic theory. Country differences in labor market competition and earnings management are also related to mean reversion in accounting returns-but the relation varies with firm performance. Country labor competition increases mean reversion when unexpected returns are positive but slows it when unexpected returns are negative. Accounting returns in countries with higher earnings management mean revert more slowly for profitable firms and more rapidly for loss firms. Thus earnings management incentives to slow or speed up mean reversion in accounting returns are accentuated in countries where there is a high propensity for earnings management. Overall, these findings suggest that country factors explain mean reversion in accounting returns and are therefore relevant for firm valuation.

The Role of the Corporation in Society: An Alternative View and Opportunities for Future Research

“…More generally, large corporations have been shown to shape culture and society by establishing hierarchies and as a result imposing a power structure in society (Perrow, 2002). The hypothesis that size is associated with power is consistent with larger companies having higher profitability margins, such as Return-on-Equity, experiencing slower mean reversion in profitability (Healy et al, 2013), and increasing more their profitability margins by the development of the financial system (Lundholm et al, 2013).…”

Competition or manipulation? An empirical evidence of determinants of the earnings persistence of the U.S. banks

“…Prior studies tend to ignore the endogeneity with respect to the causal relation between competition and earnings persistence Gropp and Kashyap, 2010;Goddard et al, 2011). Recently, Healy et al (2014) recognize that it is difficult to attribute causality between competition and earnings persistence, given many channels that drive competitive forces, such as government regulation. Our study fills this gap by employing a government regulation change as an exogenous shock that impacts bank competition.…”

Competition or Manipulation? An Empirical Evidence of Determinants of the Earnings Persistence of the U.S. Banks

“…Prior studies use different measures, such as country survey index, the Herfindahl-Hirschman Index, and the Lerner Index, to measure competition at the country, industry, firm or product level (Healy et al, 2014;Goddard et al, 2011;Berger et al, 2000). These measures, however, cannot address the endogeneity issues between competition and earnings persistence because unobservable cross-sectional heterogeneity could impact both competition and earnings persistence.…”

“…We follow Healy et al, (2014) and Flannery and Rangan (2006) to estimate Equation (8) in two steps. In the first step, we use Fama-Macbeth regression for Equation (4) and obtain an estimate of target ROA (i.e., ROAit*) (see, also, Fama and French, 2006;Healy et al, 2014). Then, we use Equation (6) to calculate the earnings GAP for each bank in each…”

“…(2) (3) (4) where (1i) is the level of persistence of ROA. In column (1), we follow Fama and French (2006) and Healy et al (2014) to use Fama-Macbeth regression for estimating ROA. t-statistics are in parentheses.…”