Stakeholders 2

Journal of Corporate Finance 62 (2020) 101606
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Journal of Corporate Finance

journal homepage: www.elsevier.com/locate/jcorpfin
Does stakeholder orientation matter for earnings management:

T
Evidence from non-shareholder constituency statutes☆
Xiaoran Ni
⁎
Department of Finance, School of Economics & Wang Yanan Institute for Studies in Economics (WISE), Xiamen University, Fujian 361005, China
ARTICLE INFO ABSTRACT
Keywords: Using a difference-in-differences methodology, this paper finds that greater stakeholder or-
Stakeholder orientation ientation due to the adoption of non-shareholder constituency statutes, which allow directors to
Non-shareholder constituency statutes consider non-shareholder stakeholders' interests in decision making, significantly reduces dis-
Earnings management cretionary accruals. The main effect is more pronounced for firms with greater tension between
shareholders and stakeholders, and with higher information acquisition costs for the board.
JEL:
Further analysis shows that stakeholder orientation increases the value-relevance of earnings,
G31
and curtails real earnings management to some extent. Overall, my findings indicate that im-
G32
G38 proved financial reporting quality can be a specific channel through which stakeholder or-
ientation increases shareholder value.
1. Introduction
How can stakeholder orientation, which allows directors to consider the interests of non-shareholder stakeholders in decision
making, affect the quality of financial reporting? This question is important because financial reporting fundamentally serves for the
decision making of shareholders and non-shareholder stakeholders. However, the traditional view of corporate governance em-
phasizes that directors should act exclusively on behalf of shareholders, and protecting the interests of other constituencies is usually
thought to be counterproductive (Tirole, 2001; Gelter, 2009; Ferrell et al., 2016; Leung et al., 2019). In this paper, I aim to further the
understanding of this issue by focusing on whether stakeholder orientation has a first-order impact on a firm's financial reporting
outcomes in view of earnings management.
Theoretically, the relation between stakeholder orientation and earnings management is ambiguous. On the one hand, stake-
holder orientation may give self-interested insiders broader scope for private benefits extraction (e.g. misuses of corporate resources)
through colluding with non-shareholder stakeholders, such as employees, which facilitates opportunistic earnings manipulation
(Jensen and Meckling, 1976; Bertrand and Mullainathan, 2003; Pagano and Volpin, 2005; Friedman, 2007; Cronqvist et al., 2009;
Masulis and Reza, 2014). Even if managers' interests are aligned with those of shareholders, stakeholder orientation may encourage
☆
I thank William L. Megginson (the Editor), two anonymous referees, Jie Chen, Martijn Cremers, Morten Holm, Woon Sau Leung, Peter Mackay,
Wei Song, Michael D. Wittry, and participants in the Asian Finance Association Annual Meeting (Ho Chi Minh City), the American Accounting
Association Annual Meeting (San Francisco) and seminars in Central University of Finance and Economics and Xiamen University for their valuable
comments. I acknowledge financial support from the National Natural Science Foundation of China (No.71802170), and the Key Laboratory of
Econometrics (Xiamen University), Ministry of Education. This project was started when I was a PhD student in Tsinghua University. Part of this
project was conducted when I was visiting Ross School of Business, University of Michigan, which I thank for the generous hospitality. All errors are
my own.
⁎
Corresponding author.
E-mail address: nxr@xmu.edu.cn.
https://doi.org/10.1016/j.jcorpfin.2020.101606
Received 1 August 2019; Received in revised form 26 January 2020; Accepted 9 March 2020
Available online 13 March 2020
0929-1199/ © 2020 Elsevier B.V. All rights reserved.
X. Ni Journal of Corporate Finance 62 (2020) 101606
managers to smooth earnings to convey more private information about a firm's future earnings and cash flows.1 Therefore, stake-
holder orientation may encourage earnings management (either opportunistic or noise-cancelling).
On the other hand, stakeholder orientation can restrain managerial earnings manipulation. In the theoretical framework of Adams
and Ferreira (2007), moral hazard problems arise because the CEO's preferred projects differ from those of the shareholders. The CEO
faces a trade-off in sharing information with the board: sharing more information improves the value of advising but also increases
the risk of board interference in decision making. When the board's preferences are strictly aligned with those of shareholders, the
CEO may intentionally engage in information asymmetry-increasing activities, such as earnings management, to make monitoring
less effective (Kim and Lu, 2017).2 Stakeholder orientation makes it more likely for the board to permit the CEO to implement
preferred projects and provide informative advice that is helpful to the CEO. As a result, the CEO will benefit from obtaining better
advice from the board through curtailing earnings management and sharing more information.3 Also, stakeholder orientation can
increase management's awareness of social responsibility issues and, relatedly, the benefits of “clean” business practices. Therefore,
managers can become more reluctant to engage in “dirty” business practices, such as earnings management, after the board becomes
more stakeholder-oriented.4
In addition, entrenched managers may have divergent interests with both stakeholders and shareholders, and they may keep on
misleading stakeholders through earnings manipulation regardless of whether the board takes a stakeholder-oriented view.
Furthermore, if managers mainly influence social responsibility decisions, the effect of board discretion can be limited. As a result,
stakeholder orientation may have no significant relation with managerial earnings management.
Given these different predictions, how stakeholder orientation affects earnings management is eventually an empirical question.
However, as the ex ante tendency of stakeholder orientation is hard to quantify and ex post socially responsible behavior is an
equilibrium outcome, identifying a causal effect is empirically challenging. To establish causality, I employ the adoption of Non-
shareholder Constituency Statutes (hereafter CS laws) in 35 states in the United States between 1984 and 2007 as quasi-exogenous
shocks.
The adoption of CS laws serves as a good candidate for quasi-exogenous shocks to stakeholder orientation for at least three
reasons. First, the adoption of CS laws expands the scope of directors' discretion, which marks a shift in legal corporate norms from
“shareholder primacy” towards greater stakeholder orientation (Orts, 1992; Luoma and Goodstein, 1999; Cremers et al., 2019; Leung
et al., 2019).5 Second, the adoption of CS laws has real effects on encouraging the formation of stakeholder-oriented boards and
stakeholder-oriented activities (Luoma and Goodstein, 1999; Cheng et al., 2018) but is not particularly intended for reducing
earnings management.6 Third, different states adopt CS laws at different points in time, which introduces both cross-sectional and
time variations in the stakeholder orientation of firms incorporated in different states (Flammer and Kacperczyk, 2016).
Using the difference-in-differences methodology, I find that firms incorporated in states with statute adoption (treatment group)
experience a significant decrease in earnings management after adoption compared to firms in states without legal changes (control
group). Specifically, my key results indicate that the adoption of CS laws is associated with a 5.2% standard deviation decrease in
discretionary accruals, the main measure of earnings management.
I then conduct a series of additional analyses to buttress my main findings. Consistent with the validity of the parallel trends
assumption that is central to a causal interpretation of the estimation results, I show that the pretreatment trends in the earnings
management of treated and control firms are statistically indistinguishable. My key results hold after controlling for confounding
factors, such as state antitakeover laws, addressing corporate lobbying issues and possible selection biases on account of the state of
incorporation choices, and employing different event windows. I further confirm that my main results are robust to various alter-
native measures of earnings management and model specifications.
In the following section, I exploit two sources of cross-sectional variation in firm characteristics and estimate triple-difference
regression models based on the theoretical implications of Adams and Ferreira (2007). First, since CS laws allow directors to pay
greater attention to the interests of non-shareholder stakeholders and, hence, encourages more credible communication of private
information, the main effect should be more pronounced for firms that have greater tension between shareholders and non-
1
Researchers who hold positive views towards earnings management argue that as true economic earnings are rather volatile and convey only
little information about future earnings and cash flows, managerial accounting discretion conveys private information through making long-term
sustainable earnings more visible, and accrual reversals ensure that earnings are unbiased in the long-term (Arya et al., 1998; Sankar and
Subramanyam, 2001).
2
In many of the scandals leading up to the enactment of SOX, information flowing from management to the board was heavily distorted, and in
some cases even falsified (Song and Thakor, 2006). One way to falsify information is to manipulate earnings upward. For example, WorldCom
categorized billions of dollars of operating costs in 2001 as capital expenditures, allowing it to report a $662 million loss as a $2.4 billion profit.
3
I will provide detailed explanation on this theoretical framework in Section 2.
4
As stakeholder orientation can induce both the board and the CEO to become more social responsible, they are more likely to come to an
agreement on social responsible projects, i.e., the interests of the CEO and the board converge. As a result, the CEO will be more willing to share
information with the board whey carrying out social responsible projects. Therefore, this channel is not mutually exclusive from the one based on
the theoretical framework of Adams and Ferreira (2007).
5
It is worth noticing that these laws do not overtake shareholder primacy, but permit directors who have incentives to act in the interest of
stakeholders. I will discuss related institutional details in Section 2.
6
Luoma and Goodstein (1999) document an increase in the representation of non-shareholder stakeholders on board following the adoption of CS
laws. Cheng et al. (2018) indicate that such laws significantly encourage CSR engagement. I also document that these legal changes has real effects
on the fraction of co-opted directors on board and thus shareholder-stakeholder relations in Section 5.2.
2
shareholder stakeholders prior to the adoption of CS laws, i.e., where managers are prone to concealing private information from
directors. Second, I predict that these legal changes will mainly affect firms with higher information acquisition costs for the board,
i.e., where ex ante external monitoring is less effective. Consistent with key elements of Adams and Ferreira's (2007) theory, I find
that the main results are more pronounced for firms with ex ante severe conflicts between shareholders and non-shareholder sta-
keholders and higher information acquisition costs for the board, which provides further support for my main arguments.
I also explore whether stakeholder orientation makes a difference in the value implications of earnings management. Managers
may use accounting discretion to reveal more private information about a firm's future earnings and cash flows (Arya et al., 1998;
Sankar and Subramanyam, 2001). Employing the model of Gao and Zhang (2015), I find that the reported earnings of smoothers that
are more stakeholder oriented are more value relevant and lead to better market valuation proxies by Tobin's Q, implying that
stakeholder orientation curtails opportunistic earnings manipulation while retaining value-relevant accounting discretions.
Last, I consider three alternative explanations of the main findings. I reject the notion that the baseline finding reflects an increase
in negative discretionary accruals rather than a decrease in positive discretionary accruals because greater stakeholder orientation can
strengthen the bargaining power of stakeholders and induce managers to manipulate earnings downward for strategic reasons
(Hilary, 2006). Additionally, I find that my main findings are unlikely driven by a channel by which stakeholder orientation shelters
managers from short-term concerns and discourages firms from concealing poor performance through earnings management. Fur-
thermore, I document that stakeholder orientation curtails two typical kinds of real earnings management, i.e., reporting abnormal
production costs and reporting abnormal reduction in discretionary expenditures, which confirms that the main effect is not driven by
the substitution between real-based and accrual-based earnings management.
This paper contributes to the literature in the following ways. My paper contributes to the growing literature on the economic
impact of stakeholder orientation, which has examined the effect of stakeholder orientation on innovation (Flammer and Kacperczyk,
2016), cost of debt (Gao et al., 2019), corporate social responsibility (Cheng et al., 2018), accounting conservatism (Radhakrishnan
et al., 2018), tax avoidance (Mathers et al., 2018), bank risk-taking (Leung et al., 2019), etc. Cremers et al. (2019) empirically show
that the adoption of CS laws increases firm value. I build my main arguments on Adams and Ferreira (2007)’s theory, and contribute
to this literature by identifying improved financial reporting quality as a specific channel through which stakeholder orientation
increases shareholder value.7
I also contribute to the literature on the economic and political determinants of earnings management (e.g. Leuz et al., 2003;
Cohen et al., 2008; Dou et al., 2016) by emphasizing the importance of state-level legal changes related to stakeholder orientation.8
As Chen et al. (2015) reveal that regulatory reforms regarding board independence reduce earnings management mainly for firms
with low information acquisition costs while CS laws are effective for firms with high information acquisition costs, my results are of
particular interest to regulators, since regulatory changes regarding stakeholder orientation complement traditional corporate
governance reforms in curbing opportunistic earnings management.
Several prior studies consider how corporate social responsibility (CSR) affects financial reporting quality (e.g., Petrovits, 2006;
Chih et al., 2008; Prior et al., 2008; Hong and Andersen, 2011; Kim et al., 2012). While these approaches have their advantages, these
studies find mixed results and do not provide conclusive evidence to establish causality owing to potential endogeneity issues.9
Although related to these works, my paper is not about how managerial discretions regarding socially responsible activities affect
financial reporting strategies. By comparison, my paper concerns how fundamental changes in the objective of directors' duties (from
shareholder-oriented to stakeholder-oriented) arising from quasi-exogenous legal shocks shape the attitude of managers towards
earnings management.10 Therefore, my paper has a more general theme.
The rest of the paper is organized as follows. Section 2 describes the institutional background. Section 3 describes the data and
empirical design. Section 4 reports estimation results on the main empirical analysis. Section 5 conducts further analysis. Section 6
concludes.
2. Institutional and theoretical background
2.1. Institutional background
Non-shareholder Constituency Statutes are the statutory result of a longstanding academic debate over corporations' purpose and
7
In general, my findings are in line with the view that stakeholder-oriented practices are beneficial to corporate wealth (Berman et al., 1999; Jiao,
2010; El Ghoul et al., 2011; Allen et al., 2014; Flammer, 2015; Bae et al., 2019; Nguyen et al., 2020).
8
Ball (2008) opines that “the cleanest research design for investigating the underlying economic and political forces behind financial reporting
involves locating genuinely exogenous shocks to the system, and tracing their effects.”
9
The major endogeneity issue is that both CSR activities and earnings management are determined by managerial discretions. Specifically,
Petrovits (2006) provides evidence that firms time contributions to their philanthropic foundations in order to achieve earnings objectives. Chih
et al. (2008) find that with a greater commitment to CSR, the extent of earnings smoothing is mitigated while the extent of earnings aggressiveness is
increased. Prior et al. (2008) find a positive impact of earnings management practices on CSR. By comparison, Hong and Andersen (2011), Kim et al.
(2012) conclude that ethics can drive managers to produce high-quality financial reports.
10
Bozzolan et al. (2015) examine the relation of CSR orientation and the trade-off between real earnings management and accrual-based earnings
management. However, they find that although CSR-oriented firms are less likely to be involved in real earnings management activities, they are
more likely to engage in accrual-based earnings management, which are different from my overall findings. Also, they employ a number-grade
rating measure as the main explanatory variable, which is more likely to capture ex-post CSR activities rather than ex-ante CSR orientation.
3
Table 1
State non-shareholder constituency statutes legislation.
Year of adoption State of incorporation # of affected firms
(1) (2) (3)
1984 OH 93
1985 IL 11
1986 ME 8
1987 AZ 14
MN 105
NM 6
NY 221
WI 43
1988 ID 3
LA 11
TN 21
VA 55
1989 FL 96
GA 48
HI 3
IN 48
IA 16
KY 7
MA 111
MO 26
NJ 108
OR 26
1990 MS 2
PA 100
RI 7
SD 2
WY 4
1991 NV 95
1993 NC 34
ND 0
1997 CT 20
1998 VT 5
1999 MD 62
2006 TX 51
2007 NE 3
This table lists in chronological order the adoption of state Non-shareholder Constituency Statutes (CS laws) by
35 states from 1984 to 2007. The list is obtained from Flammer and Kacperczyk (2016).
legal obligation to society (e.g., Bainbridge, 1992, Orts 1992). The debate originated in the 1930s, when scholars debated whether
the corporation's responsibility is to serve its shareholders exclusively or to serve a broader social purpose (Berle and Means, 1932;
Dodd, 1932). For most financial economists, good corporate governance can only be achieved if firms recognize the primacy of
shareholder interests. The implicit assumption here is that non-shareholder stakeholders of the firm are protected by contracts and
regulations (Tirole, 2001; Bénabou and Tirole, 2010; Kini et al., 2017). If that is the case, then it is unnecessary for firms to take a
stakeholder orientation.
This debate was revitalized with the development of stakeholder management theories in the 1980s, when U.S. states began to
pass Non-shareholder Constituency Statutes (CS laws) during the hostile takeover wave (Karpoff and Wittry, 2018). The CS laws
allow directors to consider non-shareholder stakeholder interests although no expressed constraints are presented on directors'
discretion in deciding how non-shareholder stakeholder interests are taken into consideration (Bainbridge, 1992). As a consequence,
even though directors in the United States have a fiduciary duty to shareholders, they may still be legally entitled to consider interests
other than those of shareholders in decision making (Adams and Ferreira, 2007).
By the end of 2007, a total of 35 incorporated states in the United States had adopted CS laws. Following Flammer and Kacperczyk
(2016), Table 1 lists all 35 states along with the enactment years and the number of affected firms.11 I use the adoption of these
statutes as quasi-exogenous shocks to examine the impact of a firm's stakeholder orientation on earnings management. The court
ruling directly impacts the fiduciary obligations of directors; therefore, the board of directors serves as a channel through which the
court ruling should take effect. Because the introduction of the statutes does not reflect any firm's strategic decision, such statutes
offer plausibly exogenous variation in a firm's orientation towards stakeholders.
Additionally, as stakeholder orientation can be beneficial to shareholders in several ways (e.g., Flammer and Kacperczyk, 2016;
11
Originally, Flammer and Kacperczyk (2016) obtain the list of state Constituency Statutes legislation from Barzuza (2009). As their sample ends
in 2006, although Nebraska passes a constituency statute in 2007, they do not show it in the Table 1 of their paper.
4
Gao et al., 2018; Cremers et al., 2019), a natural question is why shareholders do not voluntarily permit the board to adopt it in the
first place. I conjecture that although stakeholder orientation can benefit firms in the long run, shareholders can be reluctant to
initiate such changes because the adoption of stakeholder orientation may have some side effects on their incomes (at least in the
short-run), e.g., enabling directors to justify their decisions of reducing dividend payouts in the name of benefiting stakeholders.
Specifically, in Dodge v. Ford Motor Co., Henry Ford and his board of directors exercised their discretion to withhold the distribution
of Ford's capital earnings as a shareholder dividend (Bisconti, 2008). The funds were instead to be reinvested in the company to
benefit its employees. According to Henry Ford, the board withheld the dividend so that the company would be able “to employ still
more men; to spread the benefits of this industrial system to the greatest possible number, to help them build up their lives and their
homes.” However, the Michigan Supreme Court invalidated the authority of the Ford Motor Company to sacrifice profits in the name
of social responsibility.
As illustrated in this case, at least some directors' interests tend to align with these non-shareholder stakeholders. Indeed, in a
survey covering 2361 directors, Wang and Dewhirst (1992) find that the directors recognize that their responsibilities encompass
more than stockholders and are very conscious about the needs and expectations of the various constituencies of their firms.
Therefore, although statutes are somewhat permissive in nature, they are legally enforceable and can result in an important shift
away from one-dimensional shareholder primacy (Flammer and Kacperczyk, 2016). Geczy et al. (2015) indicate that most of these
court cases are positively enforced and conclude that the statutes are a “true expansion of directors' authority” to consider stakeholder
interests.
2.2. Theoretical background
In this study, I build my main argument on the theory of Adams and Ferreira (2007). They analyze the consequences of the board's
dual role as monitor as well as advisor of the CEO. In their model, when monitoring is successful, the board effectively controls
project selection, and a CEO who values control benefits is unable to implement preferred projects. When the board does not control
project selection, the board advises the CEO. Moral hazard problems arise because the CEO's preferred projects differ from those of
the shareholders, and the CEO resents monitoring but values board advising.12 Since many board members have full-time jobs in
other corporations, they rely on the CEO to provide them with relevant firm-specific information. Both advising and monitoring are
more effective when the board is better informed.
When making information-sharing decisions, the CEO must consider the trade-offs between the benefits and costs of information
sharing: sharing more information improves the value of advising but also increases the risk of board interference in decision making.
The trade-off decision can be affected by the board's preferences. When the board's preferences are strictly aligned with those of
shareholders (the board would like to choose the shareholders' preferred project), the board will intensively monitor the CEO's project
choices. Consequently, the CEO will have strong incentives to weaken monitoring through information asymmetry-increasing ac-
tivities, such as earnings management. By comparison, when the board's preferences are more closely aligned with those of the CEO
(the board would probably permit the CEO to carry out her preferred project), the board is more able to provide informative advice
that is helpful to the CEO. In this case, the CEO is able to implement preferred projects more easily and can benefit from sharing more
information with the board and obtaining better advice.13 Therefore, the marginal benefits of curtailing earnings management
(obtaining informative advice) can exceed its costs (potentially intensified monitoring) as the interests of the CEO and the board
converge.
It is pertinent to note that Adams and Ferreira (2007) incorporate the effect of CS laws into their framework. They show that when
the board's preferences are more closely aligned with those of the CEO because of the enactment of CS laws, the quality of the advice
that the board provides is higher. They therefore argue that “Non-shareholder Constituency Statutes may not be as detrimental to
shareholder value as many argue, because they allow boards' preferences to be more aligned with those of managers.” In this context,
the enactment of Non-shareholder Constituency Statutes can discourage opportunistic earnings management by aligning the board's
preferences with those of the CEO, which increases the expected gains from obtaining more informative advice from the board after
curtailing information asymmetry-increasing activities.
12
As managers work with subordinates at their disposal in day-to-day operations, their interests can be better aligned with non-shareholder
stakeholders rather than board members who work on behalf of shareholders and only meet a few times every year (Landier et al., 2012). Several
other studies also indicate that the interests of managers tend to align with non-shareholder stakeholders other than shareholders. Specifically,
stakeholders like creditors have fewer incentives to take risk and tend to focus more on long-term stability than shareholders (Fama, 1990; Becker
and Strömberg, 2012; Allen et al., 2014; Leung et al., 2019) while managers have similar incentives to take on less risk than is desired by diversified
shareholders (Jensen and Meckling, 1976; Amihud and Lev, 1981; Holmström, 1999; Gormley and Matsa, 2016). Donaldson and Lorsch (1983)
conclude from interviews that continuity of the firm is CEOs' primary objective. Donaldson and Stone (1984) describes top management's objective
as maximizing corporate wealth, not shareholder value. Acharya et al. (2011) indicate that while the CEO is myopic and self-interested, he or she
acts as if he cares about his subordinates and the survival of the firm, which is more of a concern for stakeholders.
13
Even though the CEO dislikes monitoring by the board, she still prefers a board that is more informed in decision making to an uninformed
board that interferes with her project choice. Therefore, in addition to obtain better advice, there are also some marginal expected gains from
improved monitoring by the board after sharing his information.
5
3. Data and empirical design
3.1. Sample selection
The sample period is from 1980 through 2007. I retrieve financial statement and stock price data from Compustat and CRSP. The
sample starts in 1980 so there are four years before the first adoption of CS law in 1984. I end the sample in 2007 to avoid noises from
the financial crisis.14 I exclude companies from the financial (SIC 6000–6999) and utility (SIC 4910–4939) industries. In addition, I
exclude observations with missing values of main variables. These selection criteria yield a sample of 84,460 firm-year observations.
All data are converted to real values in 2000 dollars using the consumer price index (CPI).
3.2. Dependent variables
I use discretionary accruals as the primary measure of earnings management. Total accruals can be decomposed into two parts:
nondiscretionary accruals and discretionary accruals. Nondiscretionary accruals are largely determined by the economic performance
of a firm (e.g. changes in revenues, depreciation). By comparison, discretionary accruals can measure managerial discretion in
reported earnings more precisely, and are used as the major proxy for earnings management in previous studies. Following previous
literature (Jones, 1991; Dechow et al., 1995; Fang et al., 2016), I use a modified version of the Jones model to construct the main
dependent variable DAC_FF, which denotes the residual obtained from cross-sectional regressions of total accruals on changes in sales
and on property, plant, and equipment (PPE), estimated for each Fama-French 48 industry and year pair.15
For robustness, I use alternative measures for earnings management, including various measures of residual accruals and non-
regression-based measures. I also examine whether firms with stronger stakeholder orientation have lower tendency to narrowly
meet or beat earnings targets. In addition, I examine the effect of stakeholder orientation on earnings persistence, earnings
smoothing, and real earnings management in further analysis.
3.3. Empirical design
Following Flammer and Kacperczyk (2016), I adopt the following difference-in-differences (DID) model:
EMist + 1 = + CSst + Controlist + fi + t + ist (1)
where i indexes the firm, t indexes the year, and s indexes the state of incorporation. EM refers to various measures of earnings
management. The main explanatory variable is CS, which is an indicator variable that equals one if state s has adopted the Non-
shareholder Constituency Statute in year t and zero otherwise. fi is firm-fixed effects, and τt is year-fixed effects. This approach
essentially compares the changes in earnings management among firms incorporated in states that adopt Constituency Statutes (the
treatment group) with the changes in earnings management among firms incorporated in states that do not adopt Non-shareholder
Constituency Statutes (the control group). As different states adopt Non-shareholder Constituency Statutes at different times, we are
able to make use of a variety of treatment and control groups in our analyses.
In addition to the main explanatory variable, I also introduce a vector of firm-level and state-of-headquarter-level control vari-
ables into the baseline model, including firm size, leverage, firm age, market-to-book ratio, firm growth, sales volatility, operating
cash flows, return on assets, “big-N" auditors, GDP growth, and unemployment rate. Following Massa et al. (2015), I lag all ex-
planatory variables by one year to mitigate the issue of reverse causality. I provide detailed definitions of the main variables in Table
A.1 in the Appendix.
My identification strategy relies on the assumption that the adoption of Non-shareholder Constituency Statutes is exogenous and
uncorrelated with other determinants of earnings management. Since the change in stakeholder orientation occurs at the state-of-
incorporation level, I cluster standard errors by state-of-incorporation to account for potential time-varying correlations in un-
observed factors that affect different firms incorporated within the same state (Bertrand and Mullainathan, 2003; Bertrand et al.,
2004).16
Table 2 provides summary statistics on the variables included in Eq. (1). All continuous accounting variables are winsorized at the
1st and 99th levels to eliminate outliers. Panel A shows that the mean residual accruals are 0.006, and 21.7% of the observations
belong to the treatment group. Panel B compares the variable means for the firms incorporated in states that eventually adopt the CS
laws against those of the firms incorporated in states that do not adopt these laws during the sample period. Many variables are
significantly different across the two samples. Ideally, the treatment and control firms would be relatively similar along these di-
mensions. I include each dimension as a control variable in the baseline model to control for these differences. To further address this
issue, I construct a propensity-score matched sample and re-estimate the baseline regression in Section 4.6.
14
The baseline results still hold if I extend the sample to 2014 or restrain the sample to 1983–2000. I report these results in Table 5 for robustness.
15
Since cash flow from operations (OANCF) is available only from 1987, for years before 1987, I construct the proxy for cash flow from operations
following Dou et al. (2016). The baseline results still hold if I restrain the sample to years after 1987.
16
In robustness checks, I adopt a two-way (state-of-incorporation and year) cluster strategy in the baseline model. In un-tabulated results, I also
confirm that the baseline results are robust to cluster by firm and year or simply cluster by firm.
6
Table 2
Summary statistics of main variables.
Num Mean Sd P25 Median P75
(1) (2) (3) (4) (5) (6)
DAC_FFt+1 84,460 0.006 0.135 −0.043 0.012 0.067

CS 84,460 0.225 0.418 0.000 0.000 0.000
Size 84,460 4.927 2.001 3.476 4.799 6.240
Leverage 84,460 0.223 0.203 0.042 0.190 0.344
Logage 84,460 2.243 0.846 1.609 2.303 2.944
MB 84,460 2.812 4.132 1.069 1.832 3.228
Growth 84,460 0.087 0.355 −0.053 0.057 0.197
Salevol 84,460 0.196 0.137 0.106 0.177 0.238
Cashflow 84,460 0.021 0.229 0.016 0.077 0.124
ROA 84,460 −0.029 0.243 −0.033 0.036 0.079
BigN 84,460 0.604 0.489 0.000 1.000 1.000
Gdpgrowth 84,460 0.028 0.031 0.011 0.027 0.047
Unemployment 84,460 0.059 0.018 0.047 0.056 0.068
Treatment sample (Obs. = 26,765) Control sample (Obs. = 57,695) Differences
(1) (2) (3)
DAC_FFt+1 0.015 0.002 0.012***

Size 4.846 4.964 −0.118***
Leverage 0.222 0.223 −0.001
Logage 2.397 2.172 0.225***
MB 2.552 2.932 −0.381***
Growth 0.071 0.093 −0.022***
Salevol 0.191 0.199 −0.008***
Cashflow 0.049 0.008 0.041***
ROA 0.002 −0.043 0.045***
BigN 0.583 0.614 −0.032***
Gdpgrowth 0.028 0.028 0.000**
Unemployment 0.057 0.060 −0.003***
This table reports summary statistics of variables used in the regressions estimated by the full sample consists of firm-year observations. Columns
(1)–(7) report the summary statistics of the variables in the full sample. Variable definitions are provided in Table A.1 in Appendix. ** and ***
indicate significant at 5% and 1%, respectively.
4. Main empirical analysis
4.1. Determinants of law adoption
I start by estimating Cox proportional hazard models to examine whether the adoption of CS laws in an incorporated state is
determined by state-level characteristics and, specifically, not driven by the earnings management of incorporated firms. This test
utilizes panel data at the state-of-incorporation and year levels. I define “failure event” as the adoption of CS laws in a given
incorporated state. Table 3 presents the estimation results on the adoption of CS laws. All explanatory variables are at the state-of-
incorporation level and lagged by one year. I start by only including the average level of discretionary accruals in an incorporated
state as the explanatory variable in Column (1). The coefficient estimate is positive but insignificant, suggesting that state-level
earnings management does not predict the adoption of CS laws. In Column (2), I further control for a number of state-of-incorporation
level variables, including real GDP growth, the natural log of GDP, unemployment rate, the natural log of the population, union
membership rate, and political balance.17 None of these variables are significant. These findings indicate that the adoption of CS laws
is unlikely to be driven by either firms' earnings management or political economy considerations prior to the legal changes.
4.2. Basic results
In this section, I examine the relation between stakeholder orientation and earnings management and report the estimation results
in Table 4. Column (1) estimates the baseline relation between stakeholder orientation and earnings management. The coefficient on
17
Following Acharya et al. (2014), I obtain real GDP growth, the natural log of GDP, and the natural log of the population from the U.S. Bureau of
Economic Analysis, unemployment rate from the U.S. Bureau of Labor Statistics, union membership rate from www.unionstats.com, and political
balance from the Annual Statistical Abstracts of the U.S. Census Bureau. Political balance is the ratio of Democrat-to-Republican representatives in
the Lower House (House of Representatives) for a given state and year; this variable is not available for the state of Nebraska, as it has a nonpartisan
legislature (unicameral body) whose members are elected without party designation.
7
Table 3
Determinants of adopting state non-shareholder constituency statutes.
(1) (2)
Incorporated-state discretionary accruals 0.363 0.306

(1.905) (2.621)
Incorporated-state GDP Growth 3.738
(4.296)
Incorporated-state log(GDP) 0.183
(0.588)
Incorporated-state unemployment rate 0.042
(0.131)
Incorporated-state log(population) −0.006
(0.544)
Incorporated-state union membership rate 0.008
(0.031)
Incorporated-state political balance −0.016
(0.064)
N 833 779
Adj_R2 0.000 0.009
This table reports the results from a Cox proportional hazard model where the “failure event” is the
adoption of the non-shareholder Constituency Statutes in an incorporated state, i.e. once an incorporated
state adopts the law, it drops from the sample. The sample period is from 1980 to 2007. All explanatory
variables are lagged by one year. Robust standard errors clustered at the state-of-incorporation level are
reported in parentheses.
CS is negative and significant at the 1% level, suggesting that the adoption of CS laws leads to less earnings management. Column (2)
presents the baseline specification where we include the vector of control variables introduced in Section 3.3. The coefficient on CS is
still negative and significant at the 1% level. Specifically, the adoption of CS laws is associated with a 5.2% (=0.007/0.135*100%)
standard deviation decrease in discretionary accruals.
4.3. Dynamic effects
My primary findings indicate that stakeholder orientation is associated with a reduced tendency of earnings management. In this
section, I provide further support that my setting likely satisfies the parallel trends assumption. Following Bertrand and Mullainathan
(2003), I conduct an additional test to help alleviate potential endogeneity concerns related to reverse causality. Specifically, to
address the possibility that, for example, CS law is more likely adopted by a state where incorporated firms are less likely to
manipulate earnings, I examine the timing of changes in earnings management relative to the timing of the adoption of CS laws:
EMist + 1 = µ0 + µ1 CSst 2 + µ 2 CSst 1 + µ3 CSst0 + µ4 CSst+1 + µ5 CSst2 + + Controlist + fi + t + ist (2)
where I replace CS, the main explanatory variable in Eq. (1), with several alternative dummy variables: CS−2, CS−1, CS0, CS+1, and
CS2+, which equal one for (1) two years before, (2) one year before, (3) the current year of, (4) one year after, (5) two or more years
after the adoption of CS laws in the state of incorporation. If pretreatment trends existed, then there would be a trend of declining or
increasing residual accruals before the adoption of the laws, and the coefficients on CS−2 and CS−1 would be significant.
The estimation results in Columns (3)–(4) imply that there is no pre-existing trend in residual accruals before the adoption of CS
laws, and the decrease in residual accruals emerges only after the adoption of these laws. These results indicate that my baseline
findings are unlikely to suffer from reverse causality.
To further show the dynamic relation between the adoption of CS laws and earnings management, broadly following several prior
studies (Autor et al., 2006; Acharya et al., 2014; Serfling, 2016), I present a graphical analysis in Fig. 1. Specifically, I begin by
estimating the following model:
7
EMist + 1 = 0 + j CSj + Controlist + fi + ist
j= 7 (3)
where CSj indicates year j before (when −7 ≤ j < 0) or after (when 0 < j ≤ 7) the adoption of the law. In the figure, the y-axis
plots the estimated coefficients on each main explanatory variable. The x-axis shows the time relative to the adoption of CS laws. The
dotted lines correspond to the 95% confidence intervals of the coefficient estimates based on standard errors that are clustered at the
state-of-incorporation level. The figure shows that the differences in earnings management between treated and control firms are not
statistically distinguishable from zero before the adoption of the law. By comparison, in the years after the adoption of the law,
earnings management is significantly lower for treated firms.
8
Table 4
Stakeholder orientation and earnings management.
DAC_FFt+1
(1) (2) (3) (4)
CS −0.008*** −0.007***
(0.003) (0.003)
−2
CS −0.001 0.001
(0.004) (0.004)
−1
CS −0.003 −0.003
(0.003) (0.003)
CS0 −0.010** −0.008**
(0.004) (0.004)
CS+1 −0.009** −0.004
(0.003) (0.004)
CS2+ −0.009*** −0.008**
(0.003) (0.003)
Size −0.026*** −0.026***
(0.003) (0.003)
Leverage −0.025*** −0.025***
(0.003) (0.003)
Logage 0.003 0.003
(0.002) (0.002)
MB 0.000 0.000
(0.000) (0.000)
Growth 0.004* 0.004*
(0.002) (0.002)
Salevol 0.012** 0.011**
(0.005) (0.005)
Cashflow 0.027*** 0.027***
(0.006) (0.006)
ROA 0.024*** 0.024***
(0.005) (0.005)
BigN −0.001 −0.001
(0.001) (0.001)
Gdpgrowth 0.077*** 0.077***
(0.021) (0.021)
Unemployment −0.104*** −0.105***
(0.038) (0.038)
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 95,299 84,460 95,299 84,460
Adj_R2 0.003 0.021 0.003 0.021
This table estimates the effect of stakeholder orientation on earnings management. All variables are as defined in Table A.1 in Appendix. The sample
period covers 1980 through 2007. All regressions control for year- and firm-fixed effects. Robust standard errors clustered at the state-of-in-
corporation level. Robust standard errors are reported in parentheses. Coefficients marked with *, **, and *** are significant at 10%, 5%, and 1%,
respectively.
0.02
0.01
-0.01
-0.02
-0.03
-7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7
Year Relative to Adoption of the Non-shareholder Constituency Statutes
Point Estimate 95% Confidence Interval
Fig. 1. The effect of the adoption of state non-shareholder constituency statutes on earnings management.
9
4.4. Additional controls and specific subsamples
In this section, I examine whether the negative relation between stakeholder orientation and earnings management revealed
above still holds when including additional control variables in the model and constraining observations to specific subsamples. I
report the estimation results in Table 5.
In Panel A, I examine whether confounding legal changes can affect the estimation of the effect of CS laws. First, to see whether
confounding state antitakeover laws drive my results, I follow Karpoff and Wittry (2018) and construct a comprehensive measure of
state antitakeover laws. Specifically, the indicator variable Anti-takeover equals one if a firm's state of incorporation has adopted one
of the four anti-takeover laws (Control Share Acquisition laws, Business Combination laws, Fair Price laws, and Poison Pill laws), and
zero otherwise.18 In Column (1), I still obtain negative and significant coefficients on CS after controlling for these concurrent legal
changes.
It is noteworthy that I obtain a positive but insignificant coefficient on Anti-takeover, suggesting that the adoption of anti-takeover
laws induces managers to manipulate earnings to some extent. These results are different from those of Armstrong et al. (2012), who
focus on BC laws and conclude that state antitakeover laws shelter managers from short-term concerns and improve the firm in-
formation environment. The finding here highlights the importance of taking concurrent state antitakeover laws into consideration.
Additionally, these results indicate that the effects of CS laws and state antitakeover laws on earnings management are different,
which mitigates the concern that my results simply reflect the impact of antitakeover provisions.
Huang et al. (2018) indicate that both accrual-based earnings management and real earnings management increase following a
ruling in 1999 for Ninth Circuit firms relative to other firms. In Column (2), we control for the effect of the ruling by introducing an
interaction term of the indicator variable of Ninth Circuit (Ninth) and the ruling (Post99) into the model. Consistent with their
findings, I obtain positive and significant coefficient on Ninth*Post99, and my baseline findings still hold.
In Columns (3)–(4), I consider the effect of the adoption and rejection of the Inevitable Disclosure Doctrine (IDD). Gao et al.
(2018) show that the adoption of IDD laws curtails earnings management. Flammer and Kacperczyk (2019) document that the
rejection of IDD laws between 1991 and 2013 led to an increase in CSR. To see whether these legal changes bias my estimation, I
control for their effects in the model. The negative and positive coefficients on IDD and IDDr are consistent with the findings of Gao
et al. (2018), and my main finding is largely unchanged.
In Column (5), I control for these confounding legal changes together in the model. The coefficient on CS is still negative and
significant at the 1% level, suggesting that stakeholder orientation has an unneglectable effect on earnings management, even taking
several prominent concurrent events into consideration.19
In Panel B, I rerun the baseline regression based on several specific subsamples. As indicated by Cremers et al. (2019), the exact
provisions of CS laws vary across states, and 9 out of 35 enacting states expand the scope of directors' discretion only in the takeover
context or change-of-control situations. In Column (6), to address the issue that the decrease in earnings management may be only
driven by the takeover provision effect of CS laws, I exclude firms incorporated in these states, and the baseline findings still hold.
Karpoff and Wittry (2018) indicate that several firms lobbied for the enactment of CS laws, possibly making these legal changes
endogenous in five states (Arizona, Indiana, Massachusetts, Minnesota, and Pennsylvania). In Column (7), to alleviate the potential
effects of corporate lobbying, I exclude firms incorporated in these five states, and the baseline findings are largely unchanged.
In Column (8), I address the issue that endogenous re-corporation decisions may affect the estimation of the effect of CS laws. I
exclude firms that changed the state of incorporation during the sample period.20 The estimation on the main variable CS (coeffi-
cient = −0.0082, t-statistic = 3.34) is slightly stronger than that in Column (2), Table 3 (coefficient = −0.0080, t-statistic = 3.25).
It is noteworthy that Delaware is one of the few states that do not adopt the CS law, and hence, all firms incorporated in Delaware
belong to the control group. Therefore, to some extent, my main results can be driven by changes in the earnings management of
Delaware-incorporated firms as opposed to changes among the treated firms. To address this issue, in Column (9), I only keep firm-
year observations belonging to the 35 incorporated states that eventually adopt CS laws by the end of the sample (which do not
include Delaware-incorporated firms). The coefficient on CS is still negative and significant, which mitigates the above concern.
In Panel C, I consider alternative subsample tests. In Column (10), following Basu and Liang (2019), I treat the year of CS law
adoption as the transition year and drop firm-year observations in these years. I also notice that using discretionary accruals to
measure earnings management may have drawbacks, especially for firms with extreme performance and strong growth (Dechow and
Dichev, 2002; Yu, 2008). Specifically, firms that potentially experienced transactions such as mergers & acquisitions and divestitures
may have distorted earnings measures (Hribar and Collins, 2002). In Column (11), following Basu and Liang (2019), I alleviate the
effects of such transactions by restricting the growth rate of current period sales to prior period sales to be between −50% and 100%.
In Column (12), as using the extended sample period may create noise around identification of the effect of legal changes
18
As indicated by Karpoff and Wittry (2018), these are the most common types of antitakeover laws that are passed over the same period as the CS
laws. CS laws in this paper refer to directors' duties laws (DD) in Karpoff and Wittry (2018).
19
In Section 4.4, I confirm that the main results still hold after controlling for state-of-headquarter-times-year fixed effects, where the effects of
Ninth Circuit rulings and the adoption and rejection of IDD laws will be absorbed.
20
As Compustat only provides information on the most recent state of incorporation, I use the historical state of incorporation provided by Bill
McDonald, who compiles relevant data based on firms' SEC electronic filings since 1994. For years before 1994, I use the earliest incorporation and
information available for each firm in Compustat (Gormley and Matsa, 2016). I retrieve information on the historical state of incorporation from this
link: https://sraf.nd.edu/data/.
10
Table 5
Additional controls and specific subsamples.
Panel A: Controlling for confounding law changes
DAC_FFt+1
(1) (2) (3) (4) (5)
CS −0.007*** −0.007** −0.007*** −0.007** −0.006***

(0.002) (0.003) (0.002) (0.003) (0.002)
Anti-takeover 0.003 0.004
(0.002) (0.002)
Ninth*Post 0.008*** 0.007**
(0.002) (0.003)
IDD −0.005** −0.004*
(0.002) (0.002)
IDDr 0.004 0.002
(0.003) (0.004)
Controls Y Y Y Y Y
Year FE Y Y Y Y Y
Firm FE Y Y Y Y Y
N 84,460 84,460 84,460 84,460 84,460
Adj_R2 0.021 0.021 0.021 0.021 0.021
Panel B: Specific subsample tests
DAC_FFt+1
Excluding states with restrictions Excluding lobbying states Excluding firms change incorporation states Within treatment group
(6) (7) (8) (9)
CS −0.008*** −0.008** −0.007*** −0.008**

(0.003) (0.003) (0.003) (0.003)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 81,078 79,092 81,327 24,744
Adj_R2 0.021 0.020 0.021 0.033
Panel C: Alternative subsample tests
DAC_FFt+1
Excluding current year −0.5 ≤ Sales growth ≤ 1 1983–2000 1980–2014
(10) (11) (12) (13)
CS −0.007** −0.006** −0.006** −0.007***

(0.003) (0.003) (0.003) (0.003)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 83,305 79,363 58,198 98,166
Adj_R2 0.021 0.027 0.023 0.020
Panel D: Different event windows
DAC_FFt+1
2 years around the event year 3 years around the event year 5 years around the event year 10 years around the event year
(14) (15) (16) (17)
CS −0.007*** −0.008*** −0.008*** −0.006**

(0.002) (0.002) (0.002) (0.002)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 61,004 63,228 67,547 76,192
(continued on next page)
11
Table 5 (continued)
Panel D: Different event windows
DAC_FFt+1
2 years around the event year 3 years around the event year 5 years around the event year 10 years around the event year
(14) (15) (16) (17)
Adj_R2 0.017 0.018 0.019 0.021
This table estimates the effect of stakeholder orientation on earnings management by introducing additional controls and re-estimating for specific
subsamples. All variables are as defined in Table A.1 in Appendix. The sample period covers 1980 through 2007. All regressions control for year- and
firm-fixed effects. Robust standard errors clustered at the state-of-incorporation level. Robust standard errors are reported in parentheses. Coeffi-
cients marked with *, **, and *** are significant at 10%, 5%, and 1%, respectively.
(Serfling, 2016), I restrain the sample period to 1983–2000 to exclude the effect of the passage of the Sarbanes-Oxley Act (SOX). In
Column (13), I re-estimate the baseline regression based on an extended sample for the period 1980–2014. My baseline findings still
hold during these periods.
In Panel D, following Dou et al. (2016), I examine the sensitivity of the results to using shorter windows around the events. In
Columns (14)–(17), I require that observations of firms incorporated in states that eventually adopt CS laws be within ± 2, ± 3, ± 5,
and ± 10 years around the adoption of CS laws, respectively. My baseline findings hold and become stronger for the shorter event
windows.
4.5. Alternative model specifications
My identification strategy in the previous sections relies on the assumption that the state-level adoption of CS laws is exogenous
and uncorrelated with other determinants of earnings management. In this section, I employ two alternative model specifications to
estimate the effect of CS law adoption. I report the estimation results in Table 6.
In Columns (1)–(2), I examine the effects of CS laws by using high-degree fixed effects and excluding endogenous control vari-
ables. That is, while controlling for both state-of-headquarter-by-year and industry-by-year fixed effects, I deliberately omit firm-level
Table 6
Alternative model specifications.
Gormley and Matsa (2014, 2016) Chen et al. (2018)
(1) (2) (3) (4)
CS −0.007** −0.006**
(0.003) (0.003)
CS−2 −0.006 −0.005
(0.005) (0.006)
CS−1 −0.003 −0.004
(0.004) (0.005)
CS0 −0.005 −0.004
(0.005) (0.005)
CS+1 −0.010** −0.010**
(0.004) (0.004)
CS2+ −0.009*** −0.012***
(0.003) (0.003)
1/ATt −0.098*** −0.171***
(0.029) (0.024)
ΔSalest+1-ΔARt+1 0.086*** 0.091***
(0.009) (0.007)
PPEt+1 −0.045*** −0.039***
(0.012) (0.014)
Controls N N Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
State*Year FE Y Y Y Y
Industry*Year FE Y Y Y Y
N 94,127 94,127 84,979 84,979
Adj_R2 0.146 0.146 0.324 0.329
This table estimates the effect of stakeholder orientation on earnings management based on alternative model specifications. All variables are as
defined in Table A.1 in Appendix. The sample period covers 1980 through 2007. All regressions control for year- and firm-fixed effects. Robust
standard errors clustered at the state-of-incorporation level. Robust standard errors are reported in parentheses. Coefficients marked with ** and ***
are significant at 5%, and 1%, respectively.
12
and macro-level controls in the main regression to avoid introducing additional biases into the estimation (Angrist and Pischke, 2009;
Gormley and Matsa, 2014, 2016).21 Specifically, based on the specification of Ni and Yin (2018), I estimate the following model:
EMilst + 1 = CSst + fi + kt + lt + ilst (4)
where k indexes the 2-digit SIC industry and l indexes the state of headquarters. The estimation results indicate that the negative
effect of CS laws still holds and emerges only after their adoption.
Chen et al. (2018) argue that when using a typical two-step procedure to examine determinants of discretionary accruals, the
implementation of this procedure can generate biased coefficients and standard errors. To address this issue, I employ total accruals
as the dependent variable and include variables used to estimate residual accruals (1/AT, ΔSales-ΔAR, and PPE) in the first stage as
well as the full set of control variables.22 In Columns (3)–(4), I observe a negative and significant effect of the adoption of CS laws on
total accruals, and the effect emerges only after the adoption of these laws. These tests indicate that my baseline findings are robust to
alternative model specifications.
4.6. Propensity-score matching
So far, I have documented a significant negative relation between stakeholder orientation and earnings management. However,
the choice of incorporating in states that adopt CS laws is not random, and firms incorporated in states that adopt CS laws could be
fundamentally different from the rest of the firms. Such systematic differences may drive the relation between the adoption of CS laws
and earnings management. To address this concern that cross-sectional or time series factors affect both the incorporation decision
and earnings management, I employ the propensity score matching strategy (Rosenbaum and Rubin, 1983).
The procedure of constructing the matched sample resembles that of Serfling (2016). First, I retain all observations for treated and
control firms in the year prior to the adoption of CS laws. Here, I treat each passage as a cohort. I then use a logistic regression to
estimate the probability of being a treated firm by using the vector of control variables in the baseline model as well as cohort-fixed
effects. I match each treated firm in year t-1 to the control firm in year t-1 (without replacement) with the closest propensity score
and exclude all observations that do not satisfy the common support condition. I end up with 1104 unique pairs of matched firms.
Based on the full sample again, I retain all observations of the matched pairs in the ± 5 years around the adoption of CS laws, which
consist of 18,393 firm-year observations.
I report summary statistics of the propensity score matching procedures in Table A.3 in the Appendix. In Column (1), Panel A, I
report the estimation on the baseline logistic model used to calculate propensity scores. In Column (2), I then re-estimate the model
based on the matched sample. The coefficients on all the explanatory variables have smaller magnitude and are not significant, and
the pseudo R-squire shrinks from 0.177 to 0.004, suggesting that there are largely no different observable characteristics between the
selected treatment and control groups before the regulatory change takes place. In Panel B, I show that the sample means of the
control variables for the matched treated and control firms are not significantly different, suggesting that the matching procedure is
successful.
After checking for the validity of the matching procedure, I report the estimation results in Table 7. For here, I estimate the effect
of the adoption of CS laws for the matched samples using the model specification from Columns (2) and (4) in Table 4 that includes
the vector of control variables. The estimation results indicate that after controlling for differences in firm characteristics between the
treatment and control firms, the negative relation between the adoption of CS laws and earnings management still holds and occurs
only after the adoption of these laws.
4.7. Instrumental variable approach
I further test for the validity of my identification strategy by adopting an instrumental variable approach following Flammer and
Kacperczyk (2016). I provide the results of this test in Table A.2 in the Appendix. Specifically, based on the Kinder, Lydenberg, and
Domini (KLD) database, I construct a composite firm-year measure of stakeholder orientation, KLD, by summing all strengths along
dimensions associated with stakeholder orientation. Due to data limitations, I focus on the sample period of 1995–2007 in this test.
To carry out this test, I estimate the baseline model by using KLD as the dependent variable.23 In Column (1), the coefficient on CS is
positive and significant at the 1% level, indicating that the adoption of CS laws brings about a prominent increase in stakeholder
orientation. In Column (2), I find that the instrumented KLD is negatively associated with earnings management. These results
indicate that CS laws serve as valid shocks to stakeholder orientation that bring about real changes in management's awareness of
social responsibility issues and contribute to the decrease in earnings management.
21
As 68.5% (=57,877/84,460) observations in my sample are incorporated and located in different states, I'm able to obtain estimates for the CS
laws' effects even after including state-of-headquarter-by-year fixed effects.
22
As the first stage regressions are normally conducted for each year and industry, I further include the year-industry dummies and their in-
teractions with the first-stage explanatory variables.
23
I follow Flammer and Kacperczyk (2016) and include state-of-headquarter-times-year fixed effects in the model to further control for state-level
omitted variables.
13
Table 7
Propensity-score matching.
DAC_FFt+1
(1) (2)
CS −0.010***
(0.003)
−2
CS −0.000
(0.004)
−1
CS −0.006
(0.004)
CS0 −0.012***
(0.004)
CS+1 −0.009**
(0.004)
CS2+ −0.014***
(0.004)
Controls Y Y
Year FE Y Y
Firm FE Y Y
N 18,393 18,393
Adj_R2 0.170 0.170
This table estimates the effect of stakeholder orientation on earnings management

based on a propensity-score-matched sample. All variables are as defined in Table
A.1 in Appendix. The sample period covers 1980 through 2007. All regressions
control for year- and firm-fixed effects. Robust standard errors clustered at the state-
of-incorporation level. Robust standard errors are reported in parentheses. Coeffi-
cients marked with ** and *** are significant at 5%, and 1%, respectively.
5. Further analysis
5.1. Cross-sectional tests
In this section, I exploit cross-sectional variation in firm characteristics to estimate triple-differences regression models. These
tests serve two purposes. First, they provide evidence regarding which firms are more subject to the strengthening of stakeholder
orientation and hence provide suggestive evidence for the underlying channels of the effect. Second, it is possible that unobservable
trends in earnings management or other unobservable factors affect firms incorporated in states that do and do not adopt CS laws
differently. By identifying firms in treated states that are more likely affected by the adoption of these laws and comparing groups of
firms in the same state of incorporation, the triple-differences estimator can help alleviate such concerns (Serfling, 2016).
I build the two-fold tests here based on theoretical implications of Adams and Ferreira (2007). The first set of cross-sections is
based on the ex ante tension between shareholders and stakeholders. Since CS laws allow directors to pay greater attention to the
interests of non-shareholder stakeholders and hence encourage more credible communication of private information, the main effect
should be more pronounced for firms that have greater tension between shareholders and non-shareholder stakeholders prior to the
adoption of CS laws, i.e., in cases where managers are prone to concealing private information from directors.
I employ two measures of ex ante conflicts between shareholders and non-shareholder stakeholders. First, the conflict between
shareholders and stakeholders (especially creditors) is more severe in times of financial distress when firms have a stronger desire to
manage earnings upward to avoid future covenant violations (Myers, 1977; DeFond and Jiambalvo, 1994; Becker and Strömberg,
2012). I employ Altman's (1968) index (AZ) as an inverse measure of financial distress risk. Second, shareholders and non-share-
holder stakeholders have conflicting interests over dividend payments; e.g., debt covenants often indicate that firms cannot pay
dividends if retained earnings fall below a certain level. As a result, firms under pressure of dividend payouts tend to select ac-
counting methods that increase earnings (Jensen and Meckling, 1976; Healy and Palepu, 1990; DeAngelo et al., 1994). I use the ratio
of cash dividends to total assets (Div) as the measure of dividend payouts. It is noteworthy that because major non-shareholder
stakeholders (e.g., employees, customers, suppliers) are fixed claimants of a firm who also have fewer incentives to take risk and tend
to focus more on long-term stability (Fama, 1990; Allen et al., 2014; Leung et al., 2019), these two measures are applicable to a
broader set of non-shareholder stakeholders other than creditors.
The second set of cross-sectional tests exploits the differences in information acquisition costs for the board to monitor managers. I
conjecture that when the information acquisition cost for the board is high, it is hard for the board to well carry out its monitoring
role due to the lack of information (Adams and Ferreira, 2007; Duchin et al., 2010). Because a stakeholder orientation encourages
more credible communication of private information, the curtailing effect of adopting CS laws on earnings management should be
more pronounced when the ex ante information acquisition cost for the board is higher.
I employ two measures of information acquisition cost. The first one is idiosyncratic volatility (Idiovol), a measure of stock price
infomativeness, which is negatively associated with information acquisition cost (Ferreira and Laux, 2007). The second one is analyst
forecast error (Error), a higher level of which indicates higher information acquisition cost (Chen et al., 2015) (Table 8).
14
Table 8
Cross-sectional analysis.
DAC_FFt+1
(1) (2) (3) (4)
CS*AZ 0.002***
(0.000)
AZ −0.001***
(0.000)
CS*Div −0.003***
(0.001)
Div 0.005***
(0.001)
CS*Idiovol 0.174**
(0.066)
Idiovol −0.272***
(0.050)
CS*Error −0.009**
(0.004)
Error 0.002***
(0.001)
CS −0.009* −0.008*** −0.004 0.009*
(0.005) (0.003) (0.004) (0.005)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 51,923 64,729 52,479 23,493
Adj_R2 0.143 0.168 0.140 0.158
This table explores cross-sectional differences of the effect of stakeholder orientation on earnings management. All variables are as defined in Table
A.1 in Appendix. The sample period covers 1980 through 2007. All regressions control for year- and firm-fixed effects. Robust standard errors
clustered at the state-of-incorporation level. Robust standard errors are reported in parentheses. Coefficients marked with *, **, and *** are
significant at 10%, 5%, and 1%, respectively.
In Table 8, Columns (1)–(2) show that the adoption of CS laws has a more pronounced effect on firms with higher distress risk and
a higher tendency of dividend payouts. The estimation results in Columns (3)–(4) indicate that the decrease in earnings management
is more pronounced for firms with less informative stock prices and higher analyst forecast dispersion. These results confirm my
previous conjectures, suggesting that stakeholder orientation curtails earnings management by relieving the tension between the
board and managers and encouraging more efficient communication of private information.
5.2. Stakeholder orientation and earnings persistence
Dechow et al. (2010) show that in addition to the desire to inflate earnings, an important motivation for a firm to engage in
earnings management is to show the capability of generating sustainable earnings. That is, in the absence of earnings management,
earnings will be less stable for all firms except for those with superior business fundamentals. In Table 9, following Massa et al.
(2015), we test the effect of stakeholder orientation on earnings persistence by regressing residual accruals on the interaction be-
tween CS and the lagged dependent variables. In Column (1), the coefficient on CS*DAC_FF is negative and significant at the 1% level,
indicating that the adoption of CS laws reduces the sustainability of earnings. The findings in Column (2) are similar to those in
Column (1) when using total accruals. These results indicate that stakeholder orientation reduces the persistence of accruals, which
further supports my main findings.
5.3. Stakeholder orientation, earnings smoothing, and firm value
My main findings indicate that stakeholder orientation curtails earnings management. However, I do not intend to argue that all
earnings management is detrimental. In fact, managers may use accounting discretion to reveal more private information about a
firm's future earnings and cash flows (Arya et al., 1998; Sankar and Subramanyam, 2001). That is, earnings management can be
informative to some extent. In this section, I explore the value implications of earnings management in the presence of stakeholder
orientation. To see whether earnings smoothing is more value-relevant and is rewarded by the market with a premium in stock prices,
I estimate the model below following Gao and Zhang (2015):
TobinQist = 0 + 1 CSst DAC _FFist (TASist ) + 2 DAC _FFist (TASist ) + 3 CSst + Controlist + fi + t + ist (5)
I report the estimation results in Table 10. In Column (1), I obtain a positive and significant coefficient on CS*DAC_FF, indicating
that earnings-smoothing in the presence of a stronger stakeholder orientation leads to a larger increase in firm value. In Column (2), I
use total accrual smoothing (TAS) to proxy for earnings smoothing and obtain similar results. These results suggest that the reported
earnings of smoothers that are more stakeholder oriented deviate less from their permanent earnings, and therefore, their reported
15
Table 9
Stakeholder orientation and earnings persistence.
DAC_FFt+1 TAt+1
(1) (2)
CS*DAC_FF −0.062***
(0.022)
DAC_FF 0.020*
(0.011)
CS*TA −0.075***
(0.024)
TA 0.046***
(0.011)
CS*Size 0.003* −0.004***
(0.001) (0.001)
CS*Leverage −0.002 0.004
(0.009) (0.012)
CS*Logage −0.008*** −0.007**
(0.002) (0.003)
CS*MB 0.002*** 0.002***
(0.000) (0.001)
CS*Gsale 0.010** 0.017***
(0.004) (0.005)
CS*Salevol −0.000 0.003
(0.011) (0.011)
CS*Cashflow −0.005 −0.051*
(0.027) (0.031)
CS*ROA 0.018 0.069**
(0.026) (0.031)
CS*BigN −0.002 −0.005*
(0.003) (0.003)
CS*Gdpgrowth −0.028 −0.000
(0.054) (0.062)
CS*Unemployment 0.001 −0.053
(0.105) (0.102)
CS 0.001 0.032***
(0.013) (0.010)
Controls Y Y
Year FE Y Y
Firm FE Y Y
N 84,118 85,971
Adj_R2 0.023 0.097
This table estimates the effect of stakeholder orientation on earnings persistence. All variables
are as defined in Table A.1 in Appendix. The sample period covers 1980 through 2007. All
regressions control for year- and firm-fixed effects. Robust standard errors clustered at the
state-of-incorporation level. Robust standard errors are reported in parentheses. Coefficients
marked with *, **, and *** are significant at 10%, 5%, and 1%, respectively.
earnings are more value relevant, implying that the stakeholder orientation curtails opportunistic earnings manipulation while
retaining value-relevant accounting discretion.
5.4. Other robustness checks
In this section, I re-examine the main results by considering alternative model specifications and various alternative measures of
earnings management for robustness. I report the estimation results in Table 11.
In Column (1), I adopt a two-way (state-of-incorporation and year) cluster strategy in the baseline model. In Column (2), to
address the concern that standard errors are potentially biased in typical differences-in-differences estimation due to the auto-
correlation structure of the error terms (Bertrand et al., 2004), I calculate standard errors based on the standard block bootstrap
procedure (using 500 iterations). In Column (3), to further address this issue and produce consistent standard errors, I collapse the
data into two effective periods: before and after the adoption of CS laws.24 Specifically, in the first step, I estimate Eq. (1) without the
indicator variable of the CS law and obtain regression residuals. Then, I average them for the before and after periods. In the second
step, I examine the effect of CS laws based on the two-period panel. In Column (4), I adopt the cohort-matching approach proposed by
Gormley and Matsa (2011). Specifically, I construct a cohort of treated and control firms using firm-year observations for the ten
24
As the before and after periods are undefined for firms incorporated in states that never adopt UD laws, this test involves firms incorporated in
states that eventually adopt UD laws during the sample period.
16
Table 10
Stakeholder orientation, earnings smoothing, and firm value.
TobinQ
(1) (2)
CS*DAC_FF 0.346**
(0.171)
DAC_FF 0.277***
(0.066)
CS*TAS 0.015*
(0.008)
TAS 0.004
(0.005)
CS 0.014 −0.034
(0.041) (0.049)
Controls Y Y
Year FE Y Y
Firm FE Y Y
N 55,112 36,635
Adj_R2 0.177 0.157
This table estimates the effect of stakeholder orientation on the relation between
earnings smoothing and firm value. All variables are as defined in Table A.1 in
Appendix. The sample period covers 1980 through 2007. All regressions control
for year- and firm-fixed effects. Robust standard errors clustered at the state-of-
incorporation level. Robust standard errors are reported in parentheses. Coeffi-
cients marked with *, **, and *** are significant at 10%, 5%, and 1%, respectively.
years before and the ten years after the law's adoption.25 I then pool the data across cohorts and estimate the average treatment effect.
I control for firm-cohort fixed effects, year-cohort fixed effects, and state-of-headquarter-year-cohort fixed effects in the model. My
baseline findings still hold across the different specifications above.
In Column (5), I adopt the coding of state Constituency Statutes in Karpoff and Wittry (2018) and re-examine the effect of these
legal changes. Our baseline findings are robust to these alternative model specifications. In Column (6), following Dou et al. (2016), I
include current discretionary accruals as an additional control variable, and the baseline findings are largely unchanged.26 In Column
(7), following Dou et al. (2016), I introduce state-level unemployment insurance benefits as an additional control variable. In ad-
dition, I consider that the adoption of CS laws tends to lower the cost of capital and encourage equity issuance (El Ghoul et al., 2011;
Dhaliwal et al., 2014). As firms tend to manipulate earnings upward to facilitate equity financing, the adoption of CS laws can reduce
managerial incentives for earnings manipulation by reducing the cost of capital rather than altering director discretion. To address
this concern, I include a dummy variable indicating equity issuance as an additional control variable. My baseline findings still hold
after controlling for these two variables. In Column (8), I conduct concurrent regressions by using the discretionary accruals in year t
as the dependent variable. The estimation results indicate that the adoption of CS laws has timely and persistent effects on curtailing
earnings management, which further buttresses our main findings.
I then employ a series of alternative measures of accrual-based earnings management that are widely used in the literature. The
calculation of the main measure is based on Fama-French 48 industry classification. In Column (9), I calculate residual accruals based
on SIC 2-digit industry classification and construct DAC_SIC2 and DAC_SIC3 respectively. In Column (10), I follow Kothari et al.
(2005) and further control for firm fundamentals by matching a firm with another from the same fiscal year-industry with the closest
ROA. In Column (11), I control for growth opportunities by controlling for market-to-book ratio when calculating residual accruals. In
Column (12), I adopt the approach of Dechow and Dichev (2002) and control for operating performance by regressing the results on
past, current, and future cash flows. I obtain estimation results similar with the baseline findings in these specifications.
In Column (13), I employ total accruals rather than discretionary accruals as the dependent variable. In Column (14), following
Sloan (1996), I employ a non-regression-based measure of current accruals (CA). In Column (15), I follow Irani and Oesch (2016) and
remove depreciation when constructing the CA measure. I still obtain negative and significant coefficients on CS when using CA and
CA_DEP as dependent variables. In Column (16), I estimate a logit model and find that the adoption of CS laws reduces the likelihood
that firms just meet or beat earnings expectations, further suggesting a lower tendency of upward earnings management.
25
For here, firms are not required to be in the sample for the full 20 years around the law's adoption, and firms are allowed to be chosen as
matches in multiple cohorts.
26
Angrist and Pischke (2009) indicate that a model with both fixed effects (FE) and lagged dependent variables (LDV) is challenging to estimate.
Therefore, I do not use this specification in the main sections.
17
Table 11
Additional robustness checks.
Two-way clustering Bootstrapping Collapsing Cohort-matching
DAC_FFt+1 DAC_FFt+1 DAC_FF DAC_FFt+1
(1) (2) (3) (4)
CS −0.007*** −0.007*** −0.013*** −0.004*

(0.002) (0.002) (0.002) (0.002)
Controls Y Y N Y
Year FE Y Y N Y
Firm FE Y Y Y Y
N 84,460 84,460 2564 538,888
Adj_R2 0.157 0.354 0.013 0.120
Coding of Karpoff and Wittry (2018) Controlling for current EM Controlling for UI benefit and equity issuance EM measure in year t
DAC_FFt+1 DAC_FFt+1 DAC_FFt+1 DAC_FFt
(5) (6) (7) (8)
CS −0.007** −0.007*** −0.007*** −0.006**

(0.003) (0.003) (0.003) (0.003)
DAC_FF 0.007
(0.006)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 84,460 84,118 84,460 91,959
Adj_R2 0.021 0.021 0.021 0.230
EM measure based on SIC 2-digit Performance-matched EM MB-adjusted EM measure EM measure of Dechow and Dichev
industry measure (2002)
DAC_SIC2t+1 DAC_ ROAadjt+1 DAC_MBadjt+1 DAC_DDt+1
(9) (10) (11) (12)
CS −0.006*** −0.004** −0.004* −0.005**

(0.002) (0.002) (0.002) (0.002)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 84,951 84,460 83,535 77,028
Adj_R2 0.021 0.015 0.022 0.159
Total accruals Current accruals Current accruals (Removing depreciation) Meet or beat earnings expectation
TAt+1 CAt+1 CA_DEPt+1 Beatt+1
(13) (14) (15) (16)
CS −0.005** −0.005** −0.004** −0.103**

(0.002) (0.002) (0.002) (0.052)
Controls Y Y Y Y
Year FE Y Y Y Y
Firm FE Y Y Y Y
N 86,141 82,953 83,144 86,704
Adj/Pseudo_R2 0.010 0.085 0.026 0.010
This table conducts robustness checks for the effect of stakeholder orientation on earnings management. All variables are as defined in Table A.1 in
Appendix. The sample period covers 1980 through 2007 except for specific interpretation. All regressions control for year- and firm-fixed effects.
Robust standard errors clustered at the state-of-incorporation level. Robust standard errors are reported in parentheses. Coefficients marked with *,
**, and *** are significant at 10%, 5%, and 1%, respectively.
5.5. Alternative explanations
5.5.1. Stakeholder bargaining power

One alternative explanation is that the adoption of CS laws may strengthen the bargaining power of some stakeholders (e.g.,
18
Table 12
Positive and negative discretionary accruals.
DAC_FFt+1 > 0 DAC_FFt+1 ≤ 0
(1) (2)
CS −0.004** 0.003
(0.002) (0.003)
Controls Y Y
Year FE Y Y
Firm FE Y Y
N 47,579 36,881
Adj_R2 0.277 0.318
This table estimates the effect of stakeholder orientation on positive and negative discretionary
accruals. All variables are as defined in Table A.1 in Appendix. The sample period covers 1980
through 2007. All regressions control for year- and firm-fixed effects. Robust standard errors
clustered at the state-of-incorporation level. Robust standard errors are reported in parentheses.
The coefficient marked with **is significant at 5%.
organized labor), and managers withhold positive information from these stakeholders by deflating earnings (Hilary, 2006).
Therefore, the main finding may reflect an increase in negative discretionary accruals rather than a decrease in positive discretionary
accruals. I follow Massa et al. (2015) and investigate whether the effect of stakeholder orientation concentrates in firms with ag-
gressive earnings (i.e., positive discretionary accruals), as opposed to conservative earnings (i.e., negative discretionary accruals).
In Table 12, I divide the full sample into two subgroups: DAC_FFt+1 > 0 refers to firms with positive discretionary accruals,
while DAC_FFt+1 ≤ 0 refers to firms with negative discretionary accruals. I find that stakeholder orientation affects only firms with
aggressive earnings, not those with conservative earnings. These findings are inconsistent with the notion that managers manipulate
earnings downward in reaction to the possible strengthening of stakeholder bargaining power following the adoption of CS laws.
5.5.2. Short-term pressures

Another explanation hypothesize that CS laws reduce earnings management through alleviating managerial short-termism. It is
likely that stakeholder orientation reduces the relative importance of shareholders (since constituency statutes allow companies to
explicitly consider stakeholder interests). As a result, managers might be less obsessed about meeting short-term earnings targets, and
hence feel less of a need to engage in earnings management. Also, the widespread use of accounting information by shareholders and
financial analysts creates an incentive for managers to manipulate earnings in an attempt to influence short-term stock prices (Healy
and Wahlen, 1999; Graham et al., 2005). Although CS laws can be applied to general business decisions, they are closely related to
takeovers (Bainbridge, 1992). Therefore, they can shelter managers from short-term concerns on stock prices and discourage the
concealment of poor performance through financial reports (Armstrong et al., 2012). To see whether these arguments hold, I employ
two measures of short-term pressures from investors. The first is institutional holdings owned by transient investors (Trapct). The
second one is Illiq, the illiquidity measure of Amihud (2002). I conjecture that if stakeholder orientation curtails earnings man-
agement through sheltering managers from market pressures, the main effects should be more pronounced for firms with higher
ownership by transient investors and more liquid stocks.27
In Table 13, I fail to obtain a negative coefficient on either CS*Trapct or CS*Illiq, which indicates that the relief of market
pressures is insufficient to explain the main findings.28 The positive and significant coefficient on CS*Trapct possibly indicates that
the presence of long-term investors is important for stakeholder orientation to curtail opportunistic earnings management and create
firm value.29
5.5.3. Real earnings management

In the main context of the paper, I largely focus on accrual-based measures of earnings management. However, firms may prefer
real activities manipulation because such manipulation may be harder for other counterparties (e.g., government regulators and
auditors) to detect than manipulation through accrual-based methods and thus entail lower expected private costs (Graham et al.,
2005; Cohen et al., 2008; Dichev et al., 2013; Irani and Oesch, 2016). Therefore, the observed decrease in accrual-based earnings
management can be driven by firms strategically switching to real activities manipulation. To see whether this argument is true,
following Irani and Oesch (2016), I construct abnormal levels of production costs (RM_PROD), discretionary expenses (RM_DISX), and
cash flow from operations (RM_CFO) as measures of real earnings management.30 Here, RM_PROD is a positive measure of real
27
Bushee (1998) indicates that when transient institutional ownership is high, firms tend to cut R&D expenditures as a way to reverse an earnings
decline. Fang, Tian, and Tice (2016) find that high liquidity induces managerial short-termism and discourage innovation.
28
I also use G-index and E-index to measure ex-ante short-term pressures from the takeover market and find no significant effect of anti-takeover
provisions on the relation between stakeholder orientation and earnings management (Gompers et al., 2003; Bebchuk et al., 2009).
29
Nguyen et al. (2020) find that CSR activities can create shareholder value as long as managers are properly monitored by long-term investors.
Our findings tend to be in support of theirs.
30
These measures arise from the following three manipulation methods: Reporting a lower cost of goods sold by increasing production; reducing
19
Table 13
Cross-sectional analysis on short-term pressures.
DAC_FFt+1
(1) (2)
CS*Trapct 0.022*
(0.013)
Trapct 0.045***
(0.006)
CS*Illiq 0.000
(0.001)
Illiq −0.004***
(0.000)
CS −0.006** −0.002
(0.003) (0.003)
Controls Y Y
Year FE Y Y
Firm FE Y Y
N 65,298 46,772
Adj_R2 0.169 0.170
This table examines whether the effect of stakeholder orientation on earnings man-
agement is related with the degree of short-term pressures. All variables are as de-
fined in Table A.1 in Appendix. The sample period covers 1980 through 2007. All
regressions control for year- and firm-fixed effects. Robust standard errors clustered
at the state-of-incorporation level. Robust standard errors are reported in par-
entheses. Coefficients marked with *, **, and *** are significant at 10%, 5%, and 1%,
respectively.
Table 14
Stakeholder orientation and real earnings management.
RM_PRODt+1 RM_DISXt+1 RM_CFOt+1 RM1t+1 RM2t+1
(1) (2) (3) (4) (5)
CS −0.005** 0.004* −0.003 −0.007** −0.001

(0.002) (0.002) (0.002) (0.003) (0.003)
Controls Y Y Y Y Y
Year FE Y Y Y Y Y
Firm FE Y Y Y Y Y
N 78,497 79,159 78,506 78,497 78,506
Adj_R2 0.027 0.132 0.036 0.044 0.126
This table estimates the effect of stakeholder orientation on real earnings management. All variables are as defined in Table A.1 in Appendix. The
sample period covers 1980 through 2007. All regressions control for year- and firm-fixed effects. Robust standard errors clustered at the state-of-
incorporation level. Robust standard errors are reported in parentheses. Coefficients marked with * and ** are significant at 10%, and 5%, re-
spectively.
earnings management, while RM_CFO and RM_DISX are negative measures of real earnings management. I report the estimation
results in Table 14.
In Columns (1)–(3), I find that the adoption of CS laws significantly reduces abnormal production costs and tends to constrain
abnormal reduction in discretionary expenditures. I also construct two comprehensive positive measures of real earnings manage-
ment, RM1 (=RM_PROD-RM_DISX) and RM2 (= − RM_CFO-RM_DISX). The estimation results in Columns (4)–(5) indicate that the
adoption of CS laws significantly reduces RM1, suggesting that stakeholder orientation curtails real earnings management mainly by
reducing abnormal production costs and constraining abnormal reduction in discretionary expenditures. In sum, my results indicate
that stakeholder orientation not only curtails accrual-based earnings management but also constrains real earnings management to
some extent.
(footnote continued)
discretionary expenditures, which include selling, general, and administrative expenses, advertising, and R&Ds; accelerating the timing of sales via
more favorable credit terms or steeper price discounts. To calculate these three measures, I first generate the normal levels of PROD, DISX, and CFO
through cross-sectional regression for each industry and year combination, and then use their actual level minus the normal level calculated using
the estimated coefficients. I provide details of calculating these measures in Table A.1 in the Appendix.
20
6. Conclusions
In this paper, I explore the adoption of Non-shareholder Constituency Statutes (CS laws) as staggered quasi-exogenous shocks
across different states and infer a causal relation between stakeholder orientation and earnings management. I show a strong negative
relation between stakeholder orientation and earnings management. This relation is robust across various model specifications and
multiple measures of earnings management. Further analyses indicate that the adoption of CS laws consistently reduces earnings
persistence, increases the value relevance of earnings, and restrains real earnings management, consistently suggesting that stake-
holder orientation curtails opportunistic earnings manipulation.
This paper contributes to the expanding literature on the economic impact of stakeholder orientation. The overall findings in-
dicate that improved financial reporting quality can be a specific channel through which stakeholder orientation increases share-
holder value. My results are of particular interest to regulators since stakeholder orientation can be altered through legal and
regulatory changes. Future research may evaluate other possible regulatory designs that can be used to encourage stakeholder
orientation, reduce the occurrence of accounting manipulation and avoid its associated costs.
Appendix
Table A.1
Varidble Definition.
Variables Definition
DAC_FF Discretionary accruals, estimated for each Fama-French 48 industry and year pair:
TAi, t 1 REVi, t PPEi, t
= a0 + a1 + a2 + a3 + i, t
Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1
1 REVi, t ARi, t PPEi, t
NAi, t = a0 + a1 + a2 + a3 + i, t
Ai, t 1 Ai, t 1 Ai, t 1
TAi, t
DACi, t = NAi, t
Ai, t 1
where TA denotes total accruals, computed as the difference between net income (NI) and cash flow from operations (OANCF after 1987 or
IB-ΔACT+ΔCHE+ΔLCT-ΔDLC+DP before 1987); ΔREV is the difference in sales revenues (SALE); and PPE is gross property, plant, and
equipment (PPEGT).
CS Stakeholder orientation, an indicator variable equals to one if a firm's state of incorporation has adopted Non-shareholder Constituency Statutes
(CS) in a given year, and zero otherwise.
Size Firm size, the natural log of total assets (AT).
Leverage Firm leverage, the ratio of [short-term debt (DLC) + long-term debt (DLTT)] to lagged total assets (AT).
Logage Firm age, The natural log of (the current year - the first year appears in Compustat +1)
MB Market-to-book ratio, the ratio of the market value of equity (PRCC_F × CSHO) to the book value of equity (CEQ).
Growth Firm growth, the growth rate of total sales from year t-1 to year t.
Salevol Sales volatility, the standard deviation of total sales divided by total assets in the prior 5 years.
Cashflow Operating cash flow, the ratio of operating cash flow (OANCF after 1987 or IB-ΔACT+ΔCHE+ΔLCT-ΔDLC+DP before 1987) to total assets (AT).
ROA Return on assets, the ratio of net income (NI) to total assets (AT).
BigN An indicator variable equals to one if the auditor is a Big N auditor, and zero otherwise.
Gdpgrowth State-of-headquarter level GDP growth rates from year t-1 to year t.
Unemployment State-of-headquarter level unemployment rates from year t-1 to year t.
Anti-takeover An indicator variable equals to one if a firm's state of incorporation has adopted one of the four anti-takeover laws indicated in Karpoff and Wittry
(2018) (including Control Share Acquisition laws, Business Combination laws, Fair Price laws, and Poison Pill laws), and zero otherwise.
Ninth An indicator variable equals to one if a firm's state of headquarter belongs to the Ninth Circuit, and zero otherwise.
Post99 An indicator variable equals to one if it is year 1999 or after, and zero otherwise.
IDD An indicator variable equals to one if a firm's state of headquarter has adopted the Inevitable Disclosure Doctrine in a given year, and zero
otherwise. The coding follows Gao et al. (2018).
IDDr An indicator variable equals to one if a firm's state of headquarter has rejected the Inevitable Disclosure Doctrine in a given year, and zero
otherwise. The coding follows Flammer and Kacperczyk (2019).
UI Unemployment insurance benefit, the natural log of maximum total benefits in year t-1 calculated as the product of the maximum weekly benefit
amount and the maximum duration allowed in year t-1.
Stockissue Stock issuance, a dummy variable equals to one if the ratio of the sale of common and preferred stock (SSTK) in either year t or year t + 1 is
larger than zero, and zero otherwise.
DAC_SIC2 Discretionary accruals, estimated for each SIC 2-digit industry and year pair.
DAC_ ROAadj Performance-matched discretionary accruals, DAC_FF minus the median DAC_FF for firms in the same ROA decile, which is determined by sorting
firms in each industry-year combination according to their prior year's ROA.
DAC_MBadj Discretionary accruals, calculated as including market-to-book ratio in the model when estimating for each Fama-French 48 industry and year
pair.
DAC_ DD Discretionary accruals, the residual from estimating the following equation for each Fama-French 48 industry and year pair:
TAi, t CFOt 1 CFOt CFOt + 1 REVi, t PPEi, t
= b0 + b1 + b2 + b3 + b4 + b5 + i, t
Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1
where CFO denotes cash flow from operations.
(continued on next page)
21
Table A.1 (continued)
Variables Definition
CA Current accruals, calculated as:

CATi, t CLi, t CASHi, t DEPi, t
CAi,t =
Ai, t 1
where ΔCAT is the change in current assets (ACT), ΔCL is the change in current liabilities (LCT), ΔCASH is the change in cash holdings (CHE), and
DEP is the depreciation and amortization expense (DP).
CA_DEP Current accruals, calculated as removing depreciation when calculating CA.
BEAT Meet or beat earnings expectations, an indicator equal to one if net income before extraordinary items scaled by total assets lies in [0, 0.01),
change in net income before extraordinary items scaled by total assets lies in [0, 0.01), or EPS beats analyst forecasts by one cent per share or less.
AZ Altman's (1968)Z-score, calculated as:
0.3*IB/AT+SALE/AT+1.4*RE/AT+1.2*(ACT-LCT)/AT+0.6*PRCC_F*CSHO/LT.
Div Dividend payout, the ratio of cash dividend (DVC) to total assets (AT).
Idiovol Idiosyncratic volatility, the annualized standard deviation of the residuals from regressing daily individual stock returns over the fiscal year on
the contemporaneous CRSP value-weighted market returns.
Error Analyst forecast error, the absolute value of the difference between actual earnings per share and the consensus analyst forecast before earnings
announcements, scaled by stock price at the beginning of the year.
TAS Total accrual smoothing, calculated as the volatility of net income before extraordinary items (NI) with respect to the volatility of cash flows from
operations less cash flows from extraordinary items (CFO) at the annual level over rolling six-year windows:
Std . Dev . (CFOi, t )
TASi, t =
Std . Dev . (NIi, t )
RM_PROD Abnormal production costs, calculated as:
PRODi, t 1 SALESi, t SALESi, t SALESi, t 1
= c1 + c2 + c3 + c4 + i, t
Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1
RM_DISX Abnormal discretionary expenses, calculated as:
DISXi, t 1 SALESi, t 1
= d1 + d2 + i, t
Ai, t 1 Ai, t 1 Ai, t 1
RM_CFO Abnormal cash flow from operations, calculated as:
CFOi, t 1 SALESi, t SALESi, t
= e1 + e2 + e3 + i, t
Ai, t 1 Ai, t 1 Ai, t 1 Ai, t 1
Trapct Transient institutional ownership, the institutional holdings owned by transient investors following the definition of Bushee (1998).
Illiq Stock illiquidity, the illiquidity measure constructed following Amihud (2002).
RM1 Real earnings management, RM_PROD minus RM_DISX.
RM2 Real earnings management, −RM_CFO minus RM_DISX.
Table A.2
Instrumental variable analysis.
KLD DAC_FFt+1
(1) (2)
1st stage 2nd stage
KLD −0.023**
(0.011)
CS 0.423***
(0.107)
Controls Y Y
Firm FE Y Y
State*Year FE Y Y
N 8370 8370
This table estimates the effect of stakeholder orientation on earnings management based on
the instrumental variable analysis. All variables are as defined in Table A.1 in Appendix. The
sample period covers 1995 through 2007. All regressions control for firm- and headquarter-
times-year-fixed effects. Robust standard errors clustered at the state-of-incorporation level.
Robust standard errors are reported in parentheses. Coefficients marked with ** and *** are
significant at 5%, and 1%, respectively.
22
Table A.3
Statistics of propensity score matching.
Panel A: Pre-match regression and post-match diagnostic regression
Pre-match Post-match
(1) (2)
Size −0.092*** −0.009

(0.017) (0.027)
Leverage 0.100 −0.071
(0.128) (0.219)
Logage 0.231*** −0.002
(0.040) (0.065)
MB 0.000 0.006
(0.007) (0.011)
Growth −0.105 0.007
(0.076) (0.131)
Salevol −0.414** 0.194
(0.210) (0.334)
Cashflow 0.174 0.036
(0.365) (0.746)
ROA 0.138 0.042
(0.339) (0.693)
BigN −0.118** 0.034
(0.055) (0.088)
Gdpgrowth 10.835*** 3.488
(1.477) (2.460)
Unemployment −5.213** 0.488
(2.412) (3.905)
Cohort FE Y Y
N 57,104 2208
Pseudo_R2 0.177 0.004
Panel B: Post-match differences
Treated Control T-value P-value
(N = 1104) (N = 1104)
(1) (2) (3) (4)
Size 4.521 4.567 −0.45 0.66

Leverage 0.246 0.249 −0.27 0.78
Logage 2.212 2.230 −0.44 0.66
MB 2.537 2.428 0.55 0.58
Gsale 0.078 0.073 0.27 0.79
Salevol 0.193 0.188 0.71 0.48
Cashflow 0.041 0.040 0.10 0.92
ROA −0.006 −0.007 0.07 0.95
BigN 0.542 0.535 0.27 0.79
Gdpgrowth 0.040 0.040 0.52 0.61
Unemployment 0.057 0.056 0.58 0.56
This table presents statistics of propensity score matching. Panel A presents parameter estimates from the logistic
model used to estimate propensity scores for firms in the treatment and control groups. In Panel B, Column (1)
presents sample average of firm characteristics in the treated group; Column (2) presents sample average of firm
characteristics in the control group; Column (3) presents the value of t-test of the differences between Columns (1)
and (2); Column (4) presents the significant level of the sample-mean difference test between Columns (1) and (2).
Definitions of all these variables are provided in Table A.1 in Appendix.
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Journal of Corporate Finance 62 (2020) 101606

Contents lists available at ScienceDirect

Journal of Corporate Finance

Does stakeholder orientation matter for earnings management:

ARTICLE INFO ABSTRACT

2. Institutional and theoretical background

2.1. Institutional background

(1) (2) (3)

2.2. Theoretical background

3. Data and empirical design

3.1. Sample selection

3.2. Dependent variables

3.3. Empirical design

EMist + 1 = + CSst + Controlist + fi + t + ist (1)

(1) (2) (3) (4) (5) (6)

DAC_FFt+1 84,460 0.006 0.135 −0.043 0.012 0.067

Treatment sample (Obs. = 26,765) Control sample (Obs. = 57,695) Differences

(1) (2) (3)

DAC_FFt+1 0.015 0.002 0.012***

4. Main empirical analysis

4.1. Determinants of law adoption

4.2. Basic results

Incorporated-state discretionary accruals 0.363 0.306

4.3. Dynamic effects

EMist + 1 = µ0 + µ1 CSst 2 + µ 2 CSst 1 + µ3 CSst0 + µ4 CSst+1 + µ5 CSst2 + + Controlist + fi + t + ist (2)

(1) (2) (3) (4)

4.4. Additional controls and specific subsamples

(1) (2) (3) (4) (5)

CS −0.007*** −0.007** −0.007*** −0.007** −0.006***

Panel B: Specific subsample tests

(6) (7) (8) (9)

CS −0.008*** −0.008** −0.007*** −0.008**

Panel C: Alternative subsample tests

Excluding current year −0.5 ≤ Sales growth ≤ 1 1983–2000 1980–2014

(10) (11) (12) (13)

CS −0.007** −0.006** −0.006** −0.007***

Panel D: Different event windows

(14) (15) (16) (17)

CS −0.007*** −0.008*** −0.008*** −0.006**

Panel D: Different event windows

(14) (15) (16) (17)

Adj_R2 0.017 0.018 0.019 0.021

4.5. Alternative model specifications

(1) (2) (3) (4)

EMilst + 1 = CSst + fi + kt + lt + ilst (4)

4.6. Propensity-score matching

4.7. Instrumental variable approach

This table estimates the effect of stakeholder orientation on earnings management

5.1. Cross-sectional tests

(1) (2) (3) (4)

5.2. Stakeholder orientation and earnings persistence

5.3. Stakeholder orientation, earnings smoothing, and firm value

5.4. Other robustness checks

DAC_FFt+1 DAC_FFt+1 DAC_FF DAC_FFt+1

(1) (2) (3) (4)

CS −0.007*** −0.007*** −0.013*** −0.004*

DAC_FFt+1 DAC_FFt+1 DAC_FFt+1 DAC_FFt

(5) (6) (7) (8)

CS −0.007** −0.007*** −0.007*** −0.006**

DAC_SIC2t+1 DAC_ ROAadjt+1 DAC_MBadjt+1 DAC_DDt+1

(9) (10) (11) (12)

CS −0.006*** −0.004** −0.004* −0.005**

TAt+1 CAt+1 CA_DEPt+1 Beatt+1

CS −0.007* −0.007 −0.007* −0.007 −0.006***

CS −0.008* −0.008 −0.007* −0.008

CS −0.007 −0.006 −0.006 −0.007*

CS −0.007* −0.008* −0.008* −0.006

CS −0.007* −0.007* −0.013*** −0.004*

CS −0.007 −0.007* −0.007* −0.006

CS −0.006* −0.004 −0.004* −0.005**

CS −0.005 −0.005 −0.004 −0.103