Does earnings management spread through board interlocks?

The paper investigates whether aggressive earnings management practices spread across firms sharing interlocked directors. The evidence shows that if a firm aggressively manages earnings via accruals (or production activities and discretionary expenses) manipulation in a year, any firms which are interlocked with the firm in that year and the two following years are more likely to aggressively manage earnings via accruals (or production activities and discretionary expenses, respectively) manipulation. The contagion effect is found to be more pronounced if the interlocked director is older or charged with duties which could influence financial reporting. The spread of accruals-based and real earnings management practices via board networks as evidenced in this paper implies that allowing the ‘small world’ of board directors to serve in several companies would be harmful for financial information users.