The Political Logic of Earnings Management: How Connection Type Determines Method

In our recent article, published in the British Journal of Management, we examine how the nature of political connections—whether transactional or relational—shapes the way firms manage their earnings. We argue that the structure of a firm’s political ties systematically determines its choice between accrual-based earnings management (AEM) and real earnings management (REM).

Earnings management (EM) has long been a central issue in corporate governance. Firms often manipulate reported earnings to meet targets, influence valuations, or reduce volatility. Political ties complicate this further. They can provide firms with regulatory relief, privileged access to public contracts, or informal protection from scrutiny. Existing research has mostly treated political connections in binary terms, suggesting they either embolden or constrain earnings manipulation. Yet this literature overlooks a key insight: not all political connections are alike. Without accounting for their character—how long they last, what they are based on—we risk misunderstanding how these relationships affect financial reporting.

We address this gap by applying a transactional–relational framework to corporate political strategy. Transactional ties involve short-term, issue-specific contributions aimed at immediate benefits. These connections are ad hoc and expendable, and firms with this orientation are less concerned about reputational damage to their political allies. Relational ties, by contrast, are long-term, trust-based partnerships built through repeated giving. Here, politicians are strategic partners whose reputations firms have an interest in protecting.

A politician’s reputation can suffer serious damage if a donor firm is caught manipulating its earnings, as voters may view the politician as complicit or ethically compromised by association. While corporate donations can boost campaign funds, they also expose politicians to reputational risks—especially when scandals like Enron erupt and trigger public outrage or regulatory action. Since voter trust is crucial for (re-)election, politicians instinctively distance themselves from tainted firms to avoid being swept up in the fallout. In this way, a firm’s pursuit of EM directly conflicts with a politician’s need to maintain a clean, electable image.

To test our framework, we use a dataset of US public companies’ political action committee contributions from 1999 to 2021. We measure the duration of uninterrupted political giving as a proxy for the relationship type: longer spells suggest a relational approach, shorter or intermittent ones a transactional one. We then examine how this relates to EM method.

AEM manipulates earnings using accounting estimates within GAAP—low-cost but relatively easy to detect due to the mean-reverting nature of accruals. REM involves changing real operations, such as reducing R&D or shifting production schedules. It is harder to spot but more costly and disruptive to firm performance.

Our results reveal a striking pattern. Firms with transactional political ties favour AEM. These firms appear focused on short-term benefits and show little concern for reputational fallout. Firms with relational ties, however, shift from AEM to REM. They incur the higher cost of REM to shield their political allies from the risk of public scandal. Crucially, we find that total EM does not decline. As firms reduce AEM, they increase REM by a similar amount. The method changes, but the level of manipulation remains constant.

This casts doubt on studies that interpret lower AEM as a sign of improved reporting. In fact, it may simply indicate that firms are using a more concealed—and more costly—form of EM.

We then explore what drives this behaviour. Is it the firm’s own reputation or the status of the politician? Using detailed data on political recipients—including congressional seniority and industry relevance—we find that firms are especially likely to substitute AEM with REM when they support powerful or strategically important politicians. By contrast, whether the firm is widely admired has no significant effect. This suggests that the reputational risk to the politician—not the firm—is what firms are trying to manage.

We further test our theory by looking at what happens when political trust breaks down. First, we examine firms that stop contributing to politicians after sustained relational giving. In those cases, we observe a reversion from REM back to AEM, implying that the incentive to protect allies disappears once the relationship ends. Second, following the Jack Abramoff lobbying scandal, which caused widespread loss of trust in political networks, firms tied to the scandal also reverted to AEM. In both cases, it is the breakdown in trust—not just the end of a relationship—that triggers the shift in method.

These findings have broader implications. The logic we observe—firms behaving more cautiously to protect valued relationships—extends beyond financial reporting. It likely applies in areas such as tax strategy, ESG disclosures, and supply chain governance. Wherever stakeholders possess reputational capital but limited oversight power, firms may prefer more concealed forms of behaviour.

For regulators and investors, our results suggest that monitoring how firms manage earnings is as important as tracking whether they do. REM is harder to detect and more damaging to long-term performance. Disclosures about the continuity and purpose of political contributions could offer useful insight into a firm’s financial behaviour. Boards, too, should consider that while relational political strategies may yield long-term benefits, they also carry hidden costs—both reputational and economic.

Our study thus reframes the debate: political connections do not simply raise or reduce EM—they determine how it is carried out. The political relationships firms choose to cherish, or let perish, leave a clear imprint on their financial disclosures.

The authors’ complete paper is available here.

Antonios Kallias is a Associate Professor in Accounting and Finance at Cardiff Business School, Cardiff University.

Konstantinos Kallias is a Senior Lecturer in Accounting and Finance, School of Accounting, Economics and Finance at the University of Portsmouth.

Jia Liu is a Professor in Finance, School of Accounting, Economics and Finance at the University of Portsmouth.

Kamran Malikov is an Associate Professor in Accounting, Southampton Business School at the University of Southampton.

Song Zhang is a Lecturer in Banking and Finance, University of St Andrews Business School at the University of St Andrews.