Earnings management: A new paradigm of corporate social responsibility

• Date: 01 September 2020
• DOI: http://doi.org/10.1111/basr.12198
• Published date: 01 September 2020

Bus Soc Rev. 2020;125:349–369.

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349

wileyonlinelibrary.com/journal/basr

Received: 29 January 2020

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Accepted: 4 February 2020

DOI: 10.1111/basr.12198

ORIGINAL ARTICLE

Earnings management: A new paradigm of

corporate social responsibility

SadafEhsan1

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MohammadNurunnabi2,3

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SamyaTahir1

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Maaida H.Hashmi1

© 2020 W. Michael Hoffman Center for Business Ethics at Bentley University. Published by Wiley Periodicals, Inc., 350 Main Street, Malden,

MA 02148, USA, and 9600 Garsington Road, Oxford OX4 2DQ, UK.

1Department of Management Sciences,

COMSATS University Islamabad, Lahore,

Pakistan

2St Antony's College, University of Oxford,

Oxford, UK

3Department of Accounting, Prince Sultan

University, Riyadh, Saudi Arabia

Correspondence

Mohammad Nurunnabi, St Antony's

College, University of Oxford, 62

Woodstock Road, Oxford OX2 6JF, UK.

Email: mnurunnabi@psu.edu.sa,

mohammad.nurunnabi@sant.ox.ac.uk

Abstract

The study adopted a systematic review approach to review

the existing studies on the relationship between corporate

social responsibility (CSR) and Earnings Management

(EM). The aim of this study is to determine whether CSR

is an effective tool to promote healthy relationships with

stakeholders or CSR is used as an effective strategy by

firm's mangers to hide out their involvement in (EM) prac-

tices. Results revealed that prior research on the CSR-EM

relationship is limited. The majority of the studies found

an inverse relationship between CSR and EM. Moreover,

mixed results were reported because of the lack of sufficient

theoretical support, inappropriate research designs, and var-

ying approaches to measure CSR and EM. This study also

synthesizes the various consistencies and inconsistencies

in the existing literature of CSR-EM and future research

agenda. Policymakers should reward organizations that pur-

sue CSR purely for social and environmental concerns and

at the same time they should be vigilant for those which use

CSR for shielding their EM practices.

KEYWORDS

corporate social responsibility, earnings' management, systematic review

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EHSAN Et Al.

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INTRODUCTION

After the twentieth century's corporate scandals(Xerox, Enron, Toshiba, Satyam Computer Servives

etc.), accounting earnings have attracted the attention of researchers, regulators, investors, share-

holders, and other constituents of firms, making it one of the most frequently investigated areas of

firms' performance statistics. The information asymmetry between a firm's insiders and outsiders,

the imperfect system of auditing, and the varying nature of accounting principles in treating firms'

accruals allows managers to manage their reported earnings to gain personal benefits or signal pri-

vate information to stakeholders (Healy & Wahlen, 1999) and that is called Earnings management

(EM).1

However, EM can have severe consequences because these short-term tactics, undertaken to

achieve short-term benefits, are often harmful to firms' long-term sustainability. One of the far-reach-

ing consequences of EM is the loss of credibility of a firm's financial reports, resulting an increase

in the activism and vigilance of the firm's internal and external stakeholders and a decrease in their

support (Choi, Lee, & Park, 2013). A firm's transparency and accountability in disclosing financial

information are critical to its ability to gain the support of its stakeholders and to maintain long-term

relationships. From this perspective, accurate financial reporting is closely related to corporate social

responsibility (CSR), as CSR encourages the firm to integrate social, ethical, and moral consider-

ations into its goals and to make decisions that protect the interests of a wide range of stakeholders,

including employees, customers, suppliers, investors, communities, the environment, and regulators,

to foster long-term relationships (Koehn & Ueng, 2010). Thus, financial transparency and reliability

are increasingly considered to be key elements in a firm's CSR strategy because of their importance

for shareholders and other stakeholders, including at all levels of society.

Voluminous research on CSR has been produced to determine what encourages firms to engage

in social activities. Much of the debate has focused on investigating the relationship between CSR

and financial performance (FP) and has tended to show that CSR has a positive effect on firms' FP.

However, the mechanism through which a firm enhances its FP through CSR activities has not been

well explained (Doh, Bunyaratavej, & Hahn, 2009). Therefore, clarifying the larger issue in this debate

concerning how a firm integrates CSR into its overall strategy (Jawahar & McLaughlin, 2001; Koehn

& Ueng, 2010), such as how a firm's CSR is influenced or influenced by its earnings quality, can help

to determine whether CSR restricts EM or is used by managers as a strategic shield to hide their op-

portunistic behavior in manipulating accounting numbers (Gras-Gil, Manzano, & Fernández, 2016).

However, the literature that explores the social indulgence of corporations through the lens of EM is

underdeveloped. Although a few studies have attempted to explore the CSR-EM relationship, they

have produced mixed and contradictory findings that create problems in clarifying this relationship.

One school of thought supported the negative relationship between CSR and EM under the long-

term perspective which posits that firms that endorse CSR are less likely to use EM because they are

concerned not only about their short-term profits but also about their long-term sustainable perfor-

mance for which building good relationships with broader range of stakeholders are of great impor-

tance (Chih, Shen, & Kang, 2008; Cho & Chun, 2015; Choi et al., 2013; Gras-Gil et al., 2016; Kim,

Park, & Wier, 2012). Therefore, they tend to report high-quality financial information. There is also

an opposite school of thought, according to which CSR is positively related to EM under the manage-

rial opportunism hypothesis (Grougiou, Leventis, Dedoulis, & Owusu-Ansah, 2014; Prior, Surroca,

& Tribó, 2008). This view contends that firms' managers and executives use CSR to hide their EM

practices by encouraging admiration from stakeholders to mask their opportunistic behavior.

There are certain factors involved in these inconsistent findings. One of the important factors is the

lack of consensus among researchers on the direction of causation in this relationship. Only a few stud-

ies checked the directions of causation and observed this relationship in both directions and all of these