Events

Prof. Gilles Hilary
Houston Term Professor
McDonough School of Business
Georgetown University

We investigate the relation between agency problems and earnings management in local governments. Specifically, we examine whether local governments use accounting discretion opportunistically to garner citizen support for raising property taxes, so that financial officers receive a higher compensation. Our evidence is consistent with this hypothesis. Preliminary analysis reveals that profitability – i.e., reporting a surplus – constrains government managers’ ability to raise property taxes and that lower property taxes correlate with lower managerial compensation. This creates managerial incentives to downplay profitability. Indeed, local governments use negative accruals to mitigate the positive effect of rising real estate prices on profitability when they are already running a surplus. This is particularly true when the ability to raise taxes is not prevented by strict state laws or is particularly sensitive to positive accruals. Lastly, these effects are stronger when tax assessors are entrenched professional appointees rather than elected officials.