Friday, October 22, 2021
By exploiting the staggered change of legal competition environment in 58 non-US countries, we find that firms tend to inflate their earnings when domicile countries adopt stricter competition laws, which supports the pressure effect of legal competition threats. This result is robust to alternative measures of earnings management and stringency of competition laws. Consistent with the pressure effect, firms inflate more earnings under the strength of competition laws when they face greater external pressure, receive less external discipline, and lack information transparency. In cross-country analyses, the impact of competition laws on earnings management is mitigated in IFRS countries and countries with stronger investor protection. By showing earnings inflation under stricter competition laws, this paper finds a side effect of competition laws on firms in terms of financial reporting quality, which should not be neglected by policymakers.