Firm‐Level Political Risk and Earnings Manipulation

ABSTRACT Using recently developed proxies for firm‐level political risk and earnings manipulation, we test the limited attention theory. Contrary to Hirshleifer and Teoh's core prediction that investor attention is associated with less managerial manipulation, we find that firm‐level political risk, serving as a proxy for investor attention, is positively associated with manipulative earnings management, using both accruals and real activities. The results are robust to alternative proxies for political risk and earnings manipulation, various techniques addressing endogeneity concerns, and subsamples of firms with different earnings manipulation incentives. Moreover, we find that the negative relation between earnings manipulation and subsequent operating performance is more pronounced among firms exposed to more firm‐level political risk, suggesting that firm‐level political risk is associated with managerial incentives for manipulation more than its association with the monitoring that comes with greater attention.