Real decline or cosmetic adjustment? Leverage anchored regulation and earnings management

This paper leverages a regression discontinuity design framework to assess a ‘Leverage Anchored Regulation’ policy designed to improve corporate performance and bring leverage down to reasonable levels. Contrary to its intent, we find that the policy unexpectedly spurred earnings management as firms sought to window-dress their performance. Our findings, robust to a battery of tests, indicate that in the absence of stringent monitoring against manipulation, the perceived improvements in reported performance may be largely illusory, thereby undermining the regulation’s intended benefits.