IDEAS home Printed from https://ideas.repec.org/a/bla/finrev/v61y2026i1p175-200.html

Political Risk, Political Polarization, and Earnings Management

Author

Listed:
  • Ashrafee T. Hossain
  • Mostafa Monzur Hasan
  • Abdullah‐Al Masum

Abstract

We examine how exposure to firm‐level political risk (PRISK) affects corporate earnings management (EM). We present robust evidence that heightened PRISK leads to an increase in real earnings management (REM); however, we do not find consistent evidence supporting an increase in accrual earnings management (AEM). Our results remain robust when employing difference‐in‐differences (DiD), two‐stage least squares (2SLS), propensity score matching (PSM), and additional methods designed to address endogeneity concerns. Additionally, we document that firm‐level political polarization exposure (PPE) intensifies the PRISK‐REM relationship. More interestingly, the financial market is relatively forgiving to firms that engage in REM activities in the face of both high PRISK and high PPE. Our findings provide novel insights into how PRISK shapes the financial reporting quality, and the critical role PPE plays in this relationship.

Suggested Citation

  • Ashrafee T. Hossain & Mostafa Monzur Hasan & Abdullah‐Al Masum, 2026. "Political Risk, Political Polarization, and Earnings Management," The Financial Review, Eastern Finance Association, vol. 61(1), pages 175-200, February.
    • Handle: RePEc:bla:finrev:v:61:y:2026:i:1:p:175-200
    DOI: 10.1111/fire.70013
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/fire.70013
    Download Restriction: no
    File URL: https://libkey.io/10.1111/fire.70013?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Sadok El Ghoul & Omrane Guedhami & Yang Ni & Jeffrey Pittman & Samir Saadi, 2012. "Does Religion Matter to Equity Pricing?," Journal of Business Ethics, Springer, vol. 111(4), pages 491-518, December.
    2. Bhattacharya, Utpal & Hsu, Po-Hsuan & Tian, Xuan & Xu, Yan, 2017. "What Affects Innovation More: Policy or Policy Uncertainty?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 52(5), pages 1869-1901, October.
    3. Bushman, Robert M. & Davidson, Robert H. & Dey, Aiyesha & Smith, Abbie, 2018. "Bank CEO materialism: Risk controls, culture and tail risk," Journal of Accounting and Economics, Elsevier, vol. 65(1), pages 191-220.
    4. Bailey, Warren & Chung, Y. Peter, 1995. "Exchange Rate Fluctuations, Political Risk, and Stock Returns: Some Evidence from an Emerging Market," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(4), pages 541-561, December.
    5. Jawad M. Addoum & Alok Kumar, 2016. "Political Sentiment and Predictable Returns," The Review of Financial Studies, Society for Financial Studies, vol. 29(12), pages 3471-3518.
    6. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    7. Johan Hombert & Adrien Matray, 2018. "Can Innovation Help U.S. Manufacturing Firms Escape Import Competition from China?," Journal of Finance, American Finance Association, vol. 73(5), pages 2003-2039, October.
    8. Leuz, Christian & Nanda, Dhananjay & Wysocki, Peter D., 2003. "Earnings management and investor protection: an international comparison," Journal of Financial Economics, Elsevier, vol. 69(3), pages 505-527, September.
    9. Yung, Kenneth & Root, Andrew, 2019. "Policy uncertainty and earnings management: International evidence," Journal of Business Research, Elsevier, vol. 100(C), pages 255-267.
    10. Beyer, Deborah B. & Fan, Zaifeng S., 2023. "The calming effects of conflict: The impact of partisan conflict on market volatility," International Review of Financial Analysis, Elsevier, vol. 85(C).
    11. Duchin, Ran & Ozbas, Oguzhan & Sensoy, Berk A., 2010. "Costly external finance, corporate investment, and the subprime mortgage credit crisis," Journal of Financial Economics, Elsevier, vol. 97(3), pages 418-435, September.
    12. Bena, Jan & Ortiz-Molina, Hernán & Simintzi, Elena, 2022. "Shielding firm value: Employment protection and process innovation," Journal of Financial Economics, Elsevier, vol. 146(2), pages 637-664.
    13. Xu, Nianhang & Chen, Qinyuan & Xu, Yan & Chan, Kam C., 2016. "Political uncertainty and cash holdings: Evidence from China," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 276-295.
    14. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    15. Kim, Hyunseob, 2020. "How does labor market size affect firm capital structure? Evidence from large plant openings," Journal of Financial Economics, Elsevier, vol. 138(1), pages 277-294.
    16. Brian J. Bushee, 2001. "Do Institutional Investors Prefer Near†Term Earnings over Long†Run Value?," Contemporary Accounting Research, John Wiley & Sons, vol. 18(2), pages 207-246, June.
    17. Karthik Ramanna & Sugata Roychowdhury, 2010. "Elections and Discretionary Accruals: Evidence from 2004," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 48(2), pages 445-475, May.
    18. Vivian W. Fang & Xuan Tian & Sheri Tice, 2014. "Does Stock Liquidity Enhance or Impede Firm Innovation?," Journal of Finance, American Finance Association, vol. 69(5), pages 2085-2125, October.
    19. La Porta, Rafael & Lopez-de-Silanes, Florencio & Shleifer, Andrei & Vishny, Robert, 2000. "Investor protection and corporate governance," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 3-27.
    20. Pham, Anh Viet, 2019. "Political risk and cost of equity: The mediating role of political connections," Journal of Corporate Finance, Elsevier, vol. 56(C), pages 64-87.
    21. Kelly, Bryan T. & Moskowitz, Tobias J. & Pruitt, Seth, 2021. "Understanding momentum and reversal," Journal of Financial Economics, Elsevier, vol. 140(3), pages 726-743.
    22. Hainmueller, Jens, 2012. "Entropy Balancing for Causal Effects: A Multivariate Reweighting Method to Produce Balanced Samples in Observational Studies," Political Analysis, Cambridge University Press, vol. 20(1), pages 25-46, January.
    23. Jensen, Thais Laerkholm & Leth-Petersen, Søren & Nanda, Ramana, 2022. "Financing constraints, home equity and selection into entrepreneurship," Journal of Financial Economics, Elsevier, vol. 145(2), pages 318-337.
    24. Sudheer Chava, 2014. "Environmental Externalities and Cost of Capital," Management Science, INFORMS, vol. 60(9), pages 2223-2247, September.
    25. Diana R. Franz & Hassan R. HassabElnaby & Gerald J. Lobo, 2014. "Impact of proximity to debt covenant violation on earnings management," Review of Accounting Studies, Springer, vol. 19(1), pages 473-505, March.
    26. Jeffrey D Simon, 1984. "A Theoretical Perspective on Political Risk," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 15(3), pages 123-143, September.
    27. Chan, Kam Fong & Marsh, Terry, 2021. "Asset prices, midterm elections, and political uncertainty," Journal of Financial Economics, Elsevier, vol. 141(1), pages 276-296.
    28. Lubos Pástor & Pietro Veronesi, 2012. "Uncertainty about Government Policy and Stock Prices," Journal of Finance, American Finance Association, vol. 67(4), pages 1219-1264, August.
    29. Joseph G. Altonji & Todd E. Elder & Christopher R. Taber, 2005. "Selection on Observed and Unobserved Variables: Assessing the Effectiveness of Catholic Schools," Journal of Political Economy, University of Chicago Press, vol. 113(1), pages 151-184, February.
    30. Yangyang Chen & C. S. Agnes Cheng & Shuo Li & Jingran Zhao, 2021. "The monitoring role of the media: Evidence from earnings management," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 48(3-4), pages 533-563, March.
    31. Stephen J Kobrin, 1979. "Political Risk: A Review and Reconsideration," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 10(1), pages 67-80, March.
    32. Jones, Jj, 1991. "Earnings Management During Import Relief Investigations," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 29(2), pages 193-228.
    33. Bartov, Eli & Givoly, Dan & Hayn, Carla, 2002. "The rewards to meeting or beating earnings expectations," Journal of Accounting and Economics, Elsevier, vol. 33(2), pages 173-204, June.
    34. Bonaime, Alice & Gulen, Huseyin & Ion, Mihai, 2018. "Does policy uncertainty affect mergers and acquisitions?," Journal of Financial Economics, Elsevier, vol. 129(3), pages 531-558.
    35. repec:oup:revfin:v:29:y:2016:i:12:p:3471-3518. is not listed on IDEAS
    36. Roychowdhury, Sugata, 2006. "Earnings management through real activities manipulation," Journal of Accounting and Economics, Elsevier, vol. 42(3), pages 335-370, December.
    37. Wei Chen & Paul Hribar & Samuel Melessa, 2018. "Incorrect Inferences When Using Residuals as Dependent Variables," Journal of Accounting Research, John Wiley & Sons, Ltd., vol. 56(3), pages 751-796, June.
    38. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-985, December.
    39. Azzimonti, Marina, 2018. "Partisan conflict and private investment," Journal of Monetary Economics, Elsevier, vol. 93(C), pages 114-131.
    40. Flammer, Caroline, 2021. "Corporate green bonds," Journal of Financial Economics, Elsevier, vol. 142(2), pages 499-516.
    41. Pástor, Ľuboš & Veronesi, Pietro, 2013. "Political uncertainty and risk premia," Journal of Financial Economics, Elsevier, vol. 110(3), pages 520-545.
    42. Chi, Jianxin Daniel & Su, Xunhua, 2017. "The Dynamics of Performance Volatility and Firm Valuation," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 52(1), pages 111-142, February.
    43. Gomes, Joao F., 2018. "Comment on partisan conflict and private investment," Journal of Monetary Economics, Elsevier, vol. 93(C), pages 132-134.
    44. Lili Dai & Phong Ngo, 2021. "Political Uncertainty and Accounting Conservatism," European Accounting Review, Taylor & Francis Journals, vol. 30(2), pages 277-307, March.
    45. Mehra, Rajnish & Prescott, Edward C., 1985. "The equity premium: A puzzle," Journal of Monetary Economics, Elsevier, vol. 15(2), pages 145-161, March.
    46. Anand Jha, 2019. "Financial Reports and Social Capital," Journal of Business Ethics, Springer, vol. 155(2), pages 567-596, March.
    47. Guifeng Shi & Jianfei Sun & Li Zhang, 2018. "Product market competition and earnings management: A firm†level analysis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 45(5-6), pages 604-624, May.
    48. Abe Jong & Gerard Mertens & Marieke Poel & Ronald Dijk, 2014. "How does earnings management influence investor’s perceptions of firm value? Survey evidence from financial analysts," Review of Accounting Studies, Springer, vol. 19(2), pages 606-627, June.
    49. Dane M. Christensen & Dan S. Dhaliwal & Steven Boivie & Scott D. Graffin, 2015. "Top management conservatism and corporate risk strategies: Evidence from managers' personal political orientation and corporate tax avoidance," Strategic Management Journal, Wiley Blackwell, vol. 36(12), pages 1918-1938, December.
    50. Gupta, Rangan & Mwamba, John W. Muteba & Wohar, Mark E., 2018. "The role of partisan conflict in forecasting the U.S. equity premium: A nonparametric approach," Finance Research Letters, Elsevier, vol. 25(C), pages 131-136.
    51. Rangan Gupta & Chi Keung Marco Lau & Stephen M. Miller & Mark E. Wohar, 2019. "US Fiscal Policy and Asset Prices: The Role of Partisan Conflict," International Review of Finance, International Review of Finance Ltd., vol. 19(4), pages 851-862, December.
    52. John Hughes & Jing Liu & Jun Liu, 2009. "On the relation between expected returns and implied cost of capital," Review of Accounting Studies, Springer, vol. 14(2), pages 246-259, September.
    53. Kim, Chansog (Francis) & Pantzalis, Christos & Chul Park, Jung, 2012. "Political geography and stock returns: The value and risk implications of proximity to political power," Journal of Financial Economics, Elsevier, vol. 106(1), pages 196-228.
    54. Emily Oster, 2019. "Unobservable Selection and Coefficient Stability: Theory and Evidence," Journal of Business & Economic Statistics, Taylor & Francis Journals, vol. 37(2), pages 187-204, April.
    55. Maria Boutchkova & Hitesh Doshi & Art Durnev & Alexander Molchanov, 2012. "Precarious Politics and Return Volatility," The Review of Financial Studies, Society for Financial Studies, vol. 25(4), pages 1111-1154.
    56. Jean-Noël Barrot, 2017. "Investor Horizon and the Life Cycle of Innovative Firms: Evidence from Venture Capital," Management Science, INFORMS, vol. 63(9), pages 3021-3043, September.
    57. Pathan, Shams & Haq, Mamiza & Faff, Robert & Seymour, Trent, 2021. "Institutional investor horizon and bank risk-taking," Journal of Corporate Finance, Elsevier, vol. 66(C).
    58. Cooper, Ilan & Priestley, Richard, 2011. "Real investment and risk dynamics," Journal of Financial Economics, Elsevier, vol. 101(1), pages 182-205, July.
    59. Huynh, Thanh D. & Xia, Ying, 2021. "Climate Change News Risk and Corporate Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 56(6), pages 1985-2009, September.
    60. Kyle Handley & Nuno Limão, 2018. "Trade and Investment under Policy Uncertainty: Theory and Firm Evidence," World Scientific Book Chapters, in: Policy Externalities and International Trade Agreements, chapter 4, pages 89-122, World Scientific Publishing Co. Pte. Ltd..
    61. Cohen, Daniel A. & Zarowin, Paul, 2010. "Accrual-based and real earnings management activities around seasoned equity offerings," Journal of Accounting and Economics, Elsevier, vol. 50(1), pages 2-19, May.
    62. Jens, Candace E., 2017. "Political uncertainty and investment: Causal evidence from U.S. gubernatorial elections," Journal of Financial Economics, Elsevier, vol. 124(3), pages 563-579.
    63. Marina Azzimonti, 2021. "Partisan Conflict, News, and Investors' Expectations," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 53(5), pages 971-1003, August.
    64. Griffin, Paul A. & Hong, Hyun A. & Liu, Yun & Ryou, Ji Woo, 2021. "The dark side of CEO social capital: Evidence from real earnings management and future operating performance," Journal of Corporate Finance, Elsevier, vol. 68(C).
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Wong, Jin Boon & Zhang, Qin, 2025. "The impact of political risks on carbon emissions," Energy Economics, Elsevier, vol. 141(C).
    2. Colak, Gonul & Gounopoulos, Dimitrios & Loukopoulos, Panagiotis & Loukopoulos, Georgios, 2021. "Political power, local policy uncertainty and IPO pricing," Journal of Corporate Finance, Elsevier, vol. 67(C).
    3. Peng, Daoju & Colak, Gonul & Shen, Jianfu, 2023. "Lean against the wind: The effect of policy uncertainty on a firm's corporate social responsibility strategy," Journal of Corporate Finance, Elsevier, vol. 79(C).
    4. Theodora Bermpei & Antonios Nikolaos Kalyvas & Lorenzo Neri & Antonella Russo, 2022. "Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States," Review of Quantitative Finance and Accounting, Springer, vol. 58(2), pages 795-845, February.
    5. Naser Makarem & Harjinder Singh & Nigar Sultana & Darren Henderson, 2023. "Policy uncertainty and real activities manipulation: evidence from Brexit," Review of Quantitative Finance and Accounting, Springer, vol. 61(4), pages 1415-1440, November.
    6. Hossain, Ashrafee & Masum, Abdullah-Al & Benkraiem, Ramzi, 2024. "Long-term institutional investors and climate change news Beta," Journal of Corporate Finance, Elsevier, vol. 89(C).
    7. Ahmad, Muhammad Farooq & Aziz, Saqib & El-Khatib, Rwan & Kowalewski, Oskar, 2023. "Firm-level political risk and dividend payout," International Review of Financial Analysis, Elsevier, vol. 86(C).
    8. Braam, Geert & Nandy, Monomita & Weitzel, Utz & Lodh, Suman, 2015. "Accrual-based and real earnings management and political connections," The International Journal of Accounting, Elsevier, vol. 50(2), pages 111-141.
    9. Ongsakul, Viput & Chatjuthamard, Pattanaporn & Chintrakarn, Pandej & Jiraporn, Pornsit, 2025. "Climate change exposure in uncertain times: A text-based approach," International Review of Economics & Finance, Elsevier, vol. 100(C).
    10. Basha, Shabeen Afsar & Benkraiem, Ramzi & Ben-Nasr, Hamdi & Masum, Abdullah-Al, 2025. "Does political risk exacerbate climate risk? Firm-level evidence," International Review of Financial Analysis, Elsevier, vol. 104(PA).
    11. Jairaj Gupta & Narendra Nath Kushwaha & Xia Li & Tahera Ebrahimi, 2025. "Does firm-level political risk influence earnings management?," Review of Quantitative Finance and Accounting, Springer, vol. 64(3), pages 1165-1198, April.
    12. Haijie Huang & Edward Lee & Changjiang Lyu & Zhenmei (Judy) Zhu, 2024. "Does Firm‐level Political Uncertainty Affect the Mispricing of Earnings? A Natural Experiment through Government‐to‐business Revolving Door," Abacus, Accounting Foundation, University of Sydney, vol. 60(3), pages 446-491, September.
    13. Alessandro Paolo Rigamonti & Giulio Greco & Mariarita Pierotti & Alessandro Capocchi, 2024. "Macroeconomic uncertainty and earnings management: evidence from commodity firms," Review of Quantitative Finance and Accounting, Springer, vol. 62(4), pages 1615-1649, May.
    14. Zhang, Chenyu & Qian, Aimin & Lou, Xu & Zhang, Guiling, 2024. "The politics of corporate social responsibility disclosure: Evidence from China," Economic Analysis and Policy, Elsevier, vol. 82(C), pages 1406-1428.
    15. Shrikant P. Jategaonkar & Linda M. Lovata & Xiaoxiao Song, 2023. "Growth opportunities and earnings management by cross-listed and U.S. firms," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 47(1), pages 157-183, March.
    16. Hu, Lifang, 2025. "Maturity mismatch and disinvestment as transmission mechanisms: Linking economic policy uncertainty to firm performance," China Economic Review, Elsevier, vol. 94(PB).
    17. Ashrafee Hossain & Abdullah‐al Masum & Samir Saadi & Ramzi Benkraiem & Nirmol Das, 2023. "Firm-Level Climate Change Risk and CEO Equity Incentives," Post-Print hal-04434397, HAL.
    18. Swanpitak, Tanapond & Pan, Xiaofei & Suardi, Sandy, 2020. "The value of family control during political uncertainty: Evidence from Thailand's constitutional change in 201411We are grateful for helpful comments and suggestions provided by Shu-Ching Chou, Woochan Kim, Nicolas Eugster, Yu-Shan Wei and participa," Emerging Markets Review, Elsevier, vol. 44(C).
    19. Cheng, Maoyong & Meng, Yu & Jin, Justin & Nainar, S.M. Khalid, 2024. "Leadership vacuum and corporate investment," Journal of Financial Stability, Elsevier, vol. 74(C).
    20. Al-Thaqeb, Saud Asaad & Algharabali, Barrak Ghanim, 2019. "Economic policy uncertainty: A literature review," The Journal of Economic Asymmetries, Elsevier, vol. 20(C).

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:finrev:v:61:y:2026:i:1:p:175-200. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/efaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.