Capital Market Pressures and Earnings Management: Evidence from U.S. Dual-Class Firms

Capital Market Pressures and Earnings Management: Evidence from U.S. Dual-Class Firms Feng Chen In a dual-class share structure, one class of common stock typically has more votes per share than the other, but both classes have equal or similar cash flow rights per share. While this dual-class structure is likely to entrench management, it potentially reduces capital market pressures on managers thereby reducing the need for managers to manipulate earnings. In this study, I compare the earnings management behavior among dual-class firms relative to a matched sample of single-class firms. I find that dual-class firms report a lower level of abnormal accruals, are less likely to produce small positive earnings surprises, and are less likely to release hidden earnings reserves. Further supporting the notion of reduced capital market pressures, when dual-class firms miss analysts' consensus forecasts, their three-day abnormal returns around earnings announcements are significantly less negative compared to their single-class counterparts. Dual-class firms also attract more long-term institutional investors, and have higher future operating and stock return performance. Overall, the results support the hypothesis that reduced capital market pressures lead to less short-term earnings manipulation among dualclass firms.