Does Social Trust Mitigate Earnings Management? Evidence from China

We investigate whether social trust environment influences earnings management. Using a sample of Chinese firms during 2001-2016, we find strong evidence that social trust reduces earnings management. The results suggest that a high social trust environment enhances ethical managerial behavior and thereby reduce the likelihood of earnings management. Further, we find that the negative effect of social trust on earnings management is stronger for firms with weak legal environment and high media coverage. Our additional analysis also illustrates that social trust alleviates both accrual-based and real-activity earnings management. Our results remain valid to alternative measures of trust and earnings management and to a battery of robustness checks. Overall the findings demonstrate that social trust, as a social norm, influences corporate decisions.