Advantageous Comparison And The Slippery Slope To Earnings Management

Schrand and Zechman (2012) posit that managers who engage in severe earnings management sometimes go down the "slippery slope," in which the amount of earnings management by a company increases over time. This paper proposes that psychological forces can encourage this pattern. I show that, under certain circumstances, engaging in a small amount of earnings management alters the manager's beliefs about the appropriateness of the act, which makes further earnings management more likely. Specifically, I predict and find in two experiments that making an initial decision to manage earnings creates a desire for rationalization. Participants presented with an egregious example of earnings management, which is commonly the focus of enforcement actions and press reports, engage in rationalization through a mechanism called "advantageous comparison" by which they conclude that what they did was relatively innocuous and therefore appropriate. My analysis also indicates that participants do not infer a signal about regulator intentions or the commonality of earnings management from the egregious example, and that presenting participants with an article detailing a similar example of earnings management mitigates advantageous comparison. These results have implications for academics interested in how fraud might accrete over time and for regulators and practitioners who are interested in preventing it