A cross-country study of legal-system strength and real earnings management

This paper investigates how firms' real-activities-based earnings management (RM) varies with the strength of a country's legal environment. Using cross-country data and multiple research designs, we reveal that RM increases with country-level legal strength. On the contrary, the paper reports that stronger legal system discourages accrual-based earnings management (AM). The overall evidence strongly suggests that legal environment plays a crucial role in firm's choice of earning management technique.