13صفحه pdf
The incidence of earnings management on information
asymmetry in an uncertain environment: Some Canadian
evidence
Denis Cormier∗, Sylvain Houle, Marie-Josée Ledoux
ESG UQÀM, School of Management, University of Quebec at Montreal, P.O. Box 8888, Montréal, Québec, Canada H3C 3P8
a r t i c l e i n f o
Keywords:
Corporate governance
Earnings management
Environmental uncertainty
Information asymmetry
a b s t r a c t
In this study, we investigate the association between earnings management and information
asymmetry considering environmental uncertainty. Results show that a complex and
dynamic environment weakens the relationship between discretionary accruals and information
asymmetry measured as share price volatility and bid-ask spread. More specifically,
the positive relationship between earnings management and information asymmetry is
weakened for diversified firms, those intensively investing in R&D, and those facing high
sales volatility. This highlights the difficulty for investors to assess earnings management in
an uncertain environment. Finally, in such a context, discretionary accruals are more likely
to be detected by investors for firms cross-listed on a U.S. stock exchange, a more liquid
and transparent stock market compared with the Canadian stock market.
© 2013 Published by Elsevier Inc.
1. Introduction
In this paper, we investigate the association between earnings management and information asymmetry considering
environmental uncertainty. The theory of the firm (e.g. Child, 1972; Williamson, 1975) recognizes that environmental uncertainty
places significant constraints on firms, affecting strategy and decision-making. Although firms are constrained by the
nature of their environment, managers do have opportunities to respond strategically to uncertainty (Ghosh & Olsen, 2009).
One of these opportunities is earnings management. The extent of opportunistic earnings management is likely to be higher
when information asymmetry is high (Dye, 1988; Trueman & Titman, 1988). In turn, earnings management could increase
the uncertainty for investors about the distribution of a firm’s future cash flows, which would create information asymmetry
between informed and less informed investors (Bhattacharya, Desai, & Venkataraman, 2012).
Two dimensions generally characterize environmental uncertainty: complexity and dynamism (Child, 1972; Thompson,
1967). According to Thompson (1967) and Terreberry (1968), a complex environment is one in which interactive relationships
relevant for decision making require a high degree of abstraction in order to produce manageable mappings. A dynamic
environment is one in which relevant factors for decision making are in a constant state of change.
Prior research suggests that complexity of the environment increases the difficulty for investors to assess earnings management
(Lim, Ding, & Thong, 2008). Financial reporting is expected to be more complex for firms with diversified business
and geographical operations. Hence, we expect earnings management to increase with the level of diversification and to be
more difficult to detect by stock market participants.
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