The effect of investor protection on earnings management

This thesis examines the relation between the extent of investor protection and the levels of accrualbased and real earnings management. Prior literature provided evidence of an inverse relationship between investor protection and accrual-based earnings management. Due to an increase in the extent of investor protection companies tend to use less accrual-based earnings management, instead companies tend to switch to use real earnings management. This may indicate an indirect positive relationship between investor protection and real earnings management. Together with the knowledge that real earnings management could destroy firm value an increase in investor protection might destroy firm value. The modified Jones model is used to examine the level of accrual-based earnings management, the models designed by Roychowdhury (2006) are used to examine the level of real earnings management and the period between 1999 and 2010 is studied. Samples from the U.K. and France are used in this study, classified as strong and weak investor protection countries respectively. This study shows that the levels of both types of earnings management are larger for U.K. companies compared to French companies which is not in accordance with the expectations. This may be caused by the fact that two countries are compared while prior literature examined companies from one country after a change in the extent of investor protection within this country. In this research the differences in the levels of the various types of earnings management could be caused by other variables which vary across both countries. The effect of investor protection on earnings management 2