Board Interlocks and Earnings Management Contagion

Abstract: Manipulation of stated earnings can have a severely negative impact on financial reporting quality and is a topic of interest to regulators and investors alike. This study investigates whether earnings management spreads through networks of shared directors between boards of Swedish listed companies. We use two accrual-based models to identify instances of earnings management and combine it with board member data in a sample period of 2010-2014. Our test is designed to determine whether earnings management spreads, incubates, and reappears in companies that did not previously manage earnings, analogous to how viral infections spread among humans. The findings are suggestive, but not conclusive, that earnings management is contagious and spreads through board interlocks. This is in line with previous research on U.S. data. However, we do not find support for that the board position held by the interlocked director affects the likelihood for earnings management to spread.