Corporate Lobbying, Political Protection, and Earnings Management

We provide evidence on the effects of corporate lobbying on earnings management (EM). We argue that corporate lobbying provides firms with some degree of political protection from enforcement of laws and regulations. Thus, lobbying firms face a lower threat of enforcement which in turn reduces the costs of EM for these firms. Moreover, the potentially weaker enforcement alters the relative costs of accrual management (AM) and real earnings management (RM). We expect lobbying firms to engage in more income increasing AM and less income increasing RM. We find strong evidence consistent with lobbying firms engaging in more EM (in absolute terms), more income increasing AM, and less income increasing RM. Furthermore, we find that when firms directly lobby the SEC the impact on firm AM and RM is greater compared to lobbying other government organizations. Our results are robust to several tests to rule out endogeneity as an explanation for our results and to the use of alternative estimation approaches. Overall, our evidence is consistent with lobbying firms facing lower regulatory enforcement and using this flexibility to reduce RM that is potentially value destructive