Earnings management and participation in accounting standard-setting

Recent economic and political science research suggests that the way public policy is set, and in particular the participation of those affected by it, impacts upon the outcome of the policy. Accounting standard setting has long offered such a possibility to participate via the due process approach followed by major standard setters. We review the literature on areas close to financial reporting and find arguments for why the possibility to participate in standard setting may have a positive effect on diminishing distortion of financial reporting. We also discuss reasons why such a compliance effect may be less pronounced in financial reporting. We conclude that the existence of this effect is an open question and conduct a lab experiment to examine whether the possibility to participate in accounting standard setting leads to reduced earnings management. Our results indicate that this is not the case. We interpret this result in light of recent evidence that enforcement and incentives are better predictors of accounting quality than financial reporting standards.