A product harm crisis (PHC) undermines a firm’s reputation as well as its managers’ career outlook. To shake off the stigmatization resulting from the PHC and regain a firm’s legitimacy among stakeholders, managers usually face an ethical dilemma as they choose to be transparent about the crisis’ financial implications or to obfuscate them to neutralize the negative impact of the PHC. We find evidence that managers engage in income-increasing earnings management when their firms experience PHCs. Moreover, while income-increasing earnings management in PHCs reduces the likelihood of customer loss and CEO forced turnover in the short run, such behavior can be deemed opportunistic and unethical as it carries long-run negative consequences in terms of a higher likelihood of accounting restatement and weaker future operating performance. Finally, managers in firms that are subject to stricter external monitoring and managers in firms with proactive ethical policies are less likely to engage in upward earnings management in PHCs.
Bibliographical notee thank Sophie Andousset-Coulier, Daniel Bens, Robert Bushman, Qiang Chen, Agnes Cheng, Ilia Dichev, Claude Francoeur, Simon Fung, Stephen Hillegeist, David Larcker, Vic Naiker, Jeffrey Ng, Valeri Nikolaev, Gordon Richardson, Douglas Skinner, Jennifer Wu Tucker, Yachang Zeng for their helpful suggestions. We also thank seminar participants at The Hong Kong Polytechnic University, Monash University, Concordia University, Université de Rennes I, and Deakin University as well as participants at the 2017 European Accounting Association and the 2017 Canadian Academic Accounting Association conferences for their comments. Like Jiang acknowledges financial support from the Faculty of Business and Economics of the University of Melbourne. Michel Magnan acknowledges financial support from Concordia University, the S.A. Jarislowsky Chair in Corporate Governance (Concordia University), and the Institute for Governance of Private and Public Organizations. Shafu Zhang acknowledges financial support from Nanjing University.
- Earnings management
- Ethical financial reporting
- Firm reputation
- Product harm crisis