Organizational Structure and Earnings Management

In this study, we identify a fundamental attribute of the organizational structure of the firm—the intensity of interdivisional transaction relatedness and complementarity—which contributes to earnings management. We draw from the theoretical economics literature that demonstrates that intrafirm collusion is more likely in hierarchical and complex organizational structure. We posit that intrafirm collusion toward a common organizational goal is more prevalent in highly related organizational structure because the economic welfare of economic agents is highly interdependent. Consistent with our hypothesis, we find that earnings management is positively associated with organizational relatedness. We also find that, for firms with high organizational relatedness, those with a high proportion of outside directors and high institutional equity ownership have less pronounced earnings management. Collectively, our result suggests an interaction between corporate governance structure and organizational relatedness in affecting earnings quality.