Value-Based Management Sophistication and Earnings Management

Financial accounting shall enable effective monitoring and control but can itself be subject to self-serving behavior by management, i.e., earnings management. Value-based management (VBM) systems are employed to counteract self-serving managerial behavior in general, as they shall mitigate agency problems and, thus, increase shareholder value through reduced conflicts of interest and information asymmetries. Drawing on five elements of VBM implementation, we posit that VBM sophistication is negatively associated with accrual-based earnings management and that this relation is more pronounced under a higher proportion of institutional investors. In contrast, committing to shareholder value orientation without implementing any further VBM element does not affect earnings management. We find support for our predictions using a sample of the largest European listed companies. Additional analyses show that value-based compensation drives the interaction effect, while the main effect of VBM on earnings management builds on the adoption of a value-based metric. Thus, the effectiveness of VBM in counteracting agency costs depends on its sophistication and the ownership structures of the focal firms. Furthermore, we show that management control systems, primarily for internal use, affect the reporting of financial accounting figures