In this paper, we examine the endogeous relation between abnormal insider trading and earnings management and explore whether good corporate governance could discipline opportunistic earnings management due to insiders trading. We find that managers would decrease (increase) reported earnings through managing discretionary current accruals (DCAs) before they intend to purchase (sell) more shares in subsequent periods. Meanwhile, our evidence also indicates that insiders would increase (decrease) their shareholding simply because they observed lower (high) DCAs in advance. In particular, we find that the deviation between managers’ control rights and cash flow rights would enlarge the impact of abnormal insider trading on the magnitude of earnings management, implying that firms faced with severe agency problems demand stronger corporate governance. With institutional investors and accounting firms as monitoring mechanisms, we show that corporate governance could alleviate earnings manipulation induced by insider trading.
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Financial Reporting and Business Communication Fourteenth Annual Conference