The influence of culture on real earnings management

The purpose of this paper is to extend prior literature regarding the interrelationships between national culture and accounting practices.

Using Hofstede’s (1980) cultural indices, the authors employ hierarchical linear modeling to examine the impact of economic growth (emerging markets), country, and culture on real earnings management (REM) for a sample of firms from 31 countries.

The results reveal a negative association between REM and Hofstede’s (1980) measures of individualism, masculinity, and uncertainty avoidance, but a positive association with power distance. These results hold even after controlling for discretionary accruals. The results further reveal that measures of investor protection are subsumed by culture.

The findings are limited by the use of Hofstede’s (1980) data. There is, however, a significant body of research that continues to rely on and support the use of Hofstede’s model.

The results should be of significant importance to investors who should consider cultural characteristics when assessing firm reported performance, and should prompt auditors and regulators to apply greater scrutiny to the financial reports in cultures characterized by high levels of power distance, especially given the apparent tradeoffs between accruals and REM.

The results reveal that status as an emerging market does not influence managers’ use of REM, and that the strength of a country’s investor protection mechanisms are subsumed by culture. Similarly, accounting systems (e.g. International Financial Reporting Standards), by themselves, do not bring about a convergence of managerial behavior. Rather, investors should consider culture when making decisions regarding capital allocation.

The increasing trend toward economic globalization and accounting harmonization makes the understanding of differences in accounting practices, and the possible impact of national culture on manager’s decisions, more important than ever. This research links REM to cultural values and tests for evidence that national culture, values, and structures of investor protection affect REM in the ways they affect managers’ attitudes toward the management of earnings through accruals.