Does European Union policy making explain accounting choices? An empirical analysis of the effects of investigations by
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Does European Union policy making explain accounting choices? An empirical analysis of the effects of investigations by the Directorate General for Competition on accounting choices Roland Ko¨nigsgruber • David Windisch
Ó Springer Science+Business Media New York 2012
Abstract The hypothesis that political costs caused by the regulatory process impact upon accounting has been tested extensively and has found considerable empirical support. However, most studies use data from the United States. Whether the conclusions carry over to different institutional settings is an open question. This study exploits the fact that, in the European Union, there exists a policy area— competition policy—in which the European Commission can act in a manner significantly less constrained than in most other policy areas, imposing substantial fines on companies found to be in infringement of European competition regulations. Companies investigated by the Commission’s Directorate General for Competition have strong incentives to deflect attention and keep a low profile. It is conjectured that such companies will use income-decreasing accruals in order not to appear to be making unjustified profits. The results confirm this conjecture. Keywords
Political costs Earnings management Antitrust Competition policy
1 Introduction This paper addresses the question whether costs deriving from non-market forces in the European Union (political costs) impact upon accounting choices.
R. Ko¨nigsgruber (&) Department of Accounting, Vrije Universiteit Amsterdam, De Boulelaan 1105, 1081 HV, Amsterdam, The Netherlands e-mail: [email protected] D. Windisch (&) Institute of Accounting and Control, University of Graz, Universitaetsstraße 15, 8010 Graz, Austria e-mail: [email protected]
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R. Ko¨nigsgruber, D. Windisch
This hypothesis has been tested in the United States and has found extensive empirical support. However, it is far from clear that the conclusions carry over to a different institutional context. Competition policy arguably is the policy field where the European Commission is most powerful. We therefore investigate this area in the present study. More specifically, we examine whether firms under investigation for violation of anti-cartel regulations use income-decreasing accruals in order to deflect attention. Our results show that they do and provide evidence that political cost considerations driven by EU policy-making at least in one particular setting influence accounting choice. The concept of political costs as a driver of accounting choices was pioneered by Watts and Zimmerman (1978, 1986) who suggest selection of accounting procedures to minimize reported earnings as one device that corporations employ to counter potential government intrusion. Financial reporting comes into play because reported profits that are considered high by the public will draw attention to the firm in view of their implied rents. An immediate reason to avoid drawing attention to oneself is when a firm is under investigation by a reg
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