Follow the Leader: Cross-Industry Herding in Earnings Management

We employ Vector Autoregressions and quarterly financial statement data to explicitly test for both own- and cross-industry earnings management "spillovers". We find that earnings management behavior can transmit from one industry to another, similar industry. Further, we find an indirect, information-based channel whereby earnings management information may reach less-related industries with a lag of about six months. These results provide initial evidence that managers within similar industries "herd" in their discretionary accrual strategies. That is, earnings management in one sub-industry classification provides an informative signal to other industries. Others, then, follow suit by adopting like strategies either for competitive parity or purely wealth-maximizing purposes. In addition, we find that earnings management is persistent and does not mean-revert. Thus, earnings management can have long-term permanent impacts on a firm and its financial statements. This paper presents both methodological and policy implications for the academic accounting literature.