The Reputation Effects of Earnings Management in the Internal Labor Market

The current study is designed to propose and test a model about the ethical reputation of a target manager who must decide whether to engage in earnings management. We employ an experimental approach to examine the potential negative reputation effects within the internal labor market of a firm that occur as a consequence of earnings management. We examine participants’ responses to a hypothetical (target) manager when both the target’s behavior and the corporate incentives were manipulated. Participants assessed how ethical they believed a target manager to be, based on the target’s decision regarding earnings management and the nature of the corporate incentives. Participants also assessed the target’s managerial ability. Participants’ judgments regarding the target’s morality were significantly affected by the target’s behavior, but were not affected by the incentive structure. Ability judgments were significantly and positively related with morality assessments. Further analysis indicates that morality assessments mediate the relationships between the target’s behavior and the participants’ willingness to extend work-related opportunities to the target. Implications of these results for management control systems design and for future research are discussed.