Deregulation and earnings management: The case of the U.S. airline industry

This paper examines earnings management dynamics in the airline industry during the airline industry deregulation of 1978. We expect that earnings management would increase after deregulation, since industry deregulation generally increases managerial discretion, whereas internal corporate governance systems are sluggish in adapting to newly changed environments. As corporate governance structures become more effective in tempering highly discretionary managers, and as capital markets learn more about how to design better management incentive systems, managers’ incentives and capacity to engage in earnings management will diminish. Based on industry data, we find that the magnitude of absolute values of discretionary accruals increase significantly in the post-deregulation period. Managers in the airline industry were inclined to engage in income increasing earnings management after deregulation. However, the increased level of earnings management then decreased to return close to the level seen during the regulation period. The findings support the predicted deregulation impact on earnings management dynamics.