Uncovering real earnings management: Pay attention to risk-taking behavior

Abstract

We examine the impact of corporate risk-taking on firm-level real earnings management. We find that firms with higher risk-taking engage in higher real earnings management. Our results are robust to a series of robustness tests, including simultaneous least squares approach, firm fixed effect, change analysis, and pseudo difference-in-difference analysis. Additional analyses reveal that the impact of risk-taking on real earnings management is more pronounced among firms that experience prior-year loss and are run by top-echelons who are risk lovers. Sarbanes-Oxley Act (SOX) regulation does not attenuate the positive effect of risk-taking on real earnings management. However, external monitoring by institutional investors and takeover susceptibility curb the relation between risk-taking and real earnings management. Our study highlights that outsider, such as investors and regulators, should pay close attention to a firm’s risk-taking behavior to unravel the extent of real earnings management in the firm.