Community Diversity and Earnings Management: Empirical Evidence

Local communities shape corporate activities and performance by pressuring firms to comply with their expectations. In this study, we assess whether firms headquartered in areas with more diverse communities, in terms of race, religion, gender, and age, are less prone to opportunistically manipulate their earnings. Drawing on institutional theory, we predict that greater community diversity is associated with lower earnings management, possibly due to broader and more diverse public pressure and scrutiny of firms activities. Using a sample of 12,973 U.S. firm-year observations from 2000 to 2016, we find that all four dimensions of community diversity are negatively and significantly associated with earnings management. This finding is robust to the use of three earnings management measures, considering the four dimensions of community diversity concurrently and controlling for a battery of firm-level factors. GMM and 2SLS models, as well as additional analyses, also support the existence of a negative association between earnings management and community diversity. We contribute to the accounting literature by providing evidence that a rarely studied institutional and multidimensional diversity characteristic (i.e., local community diversity) shapes firms earnings management.