International Journal of Business and Social Science

ISSN 2219-1933 (Print), 2219-6021 (Online) DOI: 10.30845/ijbss

Louisiana’s Distinct Legal System and its Effect on Earnings Management
Albi Alikaj, Cau Ngoc Nguyen, Wei Ning

This paper measures the degree to which managers engage in earnings management for firms incorporated in 28 U.S. states and compares Louisiana with the other 27 states. The motivation of this study is because Louisiana is the only U.S. state whose legal system is based on the French civil law. Previous research suggests that French civil law provides the weakest investor protection, while the common law provides the strongest investor protection. In addition, further research found that the legal system is a strong determinant of earnings management. More specifically, investor protection is negatively associated with earnings management. Four types of earnings management were compared, including earnings smoothing for poor performance, earnings smoothing to conceal economic shocks, earnings discretion measure: magnitude of accruals, and earnings discretion measure: small loss avoidance. Of the four measures, only one (earnings smoothing for poor performance) showed a clear distinction between earnings management in Louisiana and in other states. This measure focused on the degree to which managers would reduce the variability of reported earnings by altering accruals.

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