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Employee turnover likelihood and earnings management: evidence from the inevitable disclosure doctrine

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Abstract

We present evidence that managers consider employee turnover likelihood in their accounting choices. Our tests exploit U.S. state courts’ staggered recognition of the inevitable disclosure doctrine (IDD), which reduces employees’ ability to switch employers. We find a significant decrease in upward earnings management for firms headquartered in states that recognize the IDD, relative to firms headquartered elsewhere. The effect of the IDD is stronger for firms relying more on human capital and for firms whose employees have higher ex-ante turnover likelihood, confirming the employee retention channel. Overall, our results support the view that retaining employees is an important motive for corporate earnings management.

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Notes

  1. For example, firms may increase their investment in laboratory equipment.

  2. An extensive literature shows that firms usually locate their core business activities and R&D facilities close to their headquarters (e.g., Howells 1990; Pirinsky and Wang 2006; Breschi 2008). Therefore it is reasonable to assume that a significant part of the firm’s key employees, who know its trade secrets, work in the firm’s headquarters state.

  3. IPUMS database categorizes occupations into seven groups: 1) management, professional, and related occupations; 2) service occupations; 3) sales and office occupations; 4) farming, fishing, and forestry occupations; 5) construction, extraction, and maintenance occupations; 6) production, transportation, and material mobbing occupations; and 7) military-specific occupations.

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Acknowledgements

We are grateful for the helpful comments from Scott Richardson (editor), an anonymous referee, Agnes Cheng, Zhonglan Dai, Yiwei Dou (the discussant at the 2017 China International Conference in Finance), Andrew Winton, the seminar participants at Nanyang Technological University, and the conference participants at 2017 China International Conference in Finance. Huai Zhang acknowledges the financial support from Singapore Ministry of Education for providing research funding (RG76/13). Huasheng Gao acknowledges the financial support from Shanghai Pujiang Program. All errors are our own.

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  1. Fanhai International School of Finance, Fudan University, Shanghai, China

    Huasheng Gao

  2. Nanyang Business School, Nanyang Technological University, Singapore, Singapore

    Huai Zhang

  3. Monash Business School, Monash University, Melbourne, Australia

    Jin Zhang

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  1. Huasheng Gao
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  2. Huai Zhang
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  3. Jin Zhang
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Correspondence to Huasheng Gao.

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Table 13 Variable definitions
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Gao, H., Zhang, H. & Zhang, J. Employee turnover likelihood and earnings management: evidence from the inevitable disclosure doctrine. Rev Account Stud 23, 1424–1470 (2018). https://doi.org/10.1007/s11142-018-9475-x

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