Economic policy uncertainty exposure and earnings management: evidence from China

We investigate the impact of economic policy uncertainty (EPU) exposure on the earnings management behaviour of Chinese firms. We find a significantly positive relation between EPU exposure and firms' earnings management. In addition, the EPU exposure effect is more pronounced for firms with weaker external monitoring mechanisms. We also find that the financial leverage and growth rate of individual stocks have significant predictive ability for EPU exposure. When we examine the potential mechanisms linking EPU exposure to earnings management, we find that financial distress is the dominant mechanism for firms with high leverage, while it is cash flow volatility for the high-growth firms.