Earnings management in interconnected networks: a perspective

Purpose - The purpose of this paper is to examine how firms manage earnings when firms are in interconnected networks, that is, when firms are interconnected to each other in a way that the survival of one firm is crucial to the survival of other firms connected to it. Design/methodology/approach - The paper employs network typology to provide some insight on the earnings management behaviour of firms in regulated and unregulated networks or systems. Findings - The author shows that firms in the inner core of interconnected networks are more likely to rely on income-smoothing behaviour as a preferred form of earnings management because it stabilises the firm’s link with other firms in the network. In regulated networks, the author proposes a negative relationship between a firm’s network centrality and the number of earnings management strategies the manager can adopt. Also, the author proposes a positive relationship between a firm’s network centrality and the propensity to smooth earnings or income when firms are concerned about their reputation or regulatory scrutiny. Originality/value - This paper is a brief note on earnings management, and is the first study to provide a perspective on how earnings management can be explained using a network typology.