My study examines the effect of regulatory pressures on the earnings management behavior of nonprofit (i.e., tax-exempt) hospitals. Prior research provides evidence that managers of nonprofit hospitals manage reported earnings to a range just above zero profit in order to conform to regulator low or zero profit expectations. I extend this research by investigating how reported performance on another accounting measure important to regulators, (i.e., charity care), further explains the earnings management behavior of nonprofit hospitals. Specifically, I develop theory to predict that nonprofit hospitals use discretionary accruals to manage positive earnings toward regulator low profit expectations less aggressively when reported performance on charity care is higher than regulator expectations. The intuition behind this prediction is that nonprofit hospital managers can benefit from reporting higher earnings (from profit-based compensation and/or enhanced reputations for operational efficiency), however, they must balance this against the costs of regulatory scrutiny. Results are consistent with my prediction. Further, I validate that my results are not alternatively explained by the mechanical relationship of my test variables, the general hospital economic environment, and/or the specific reporting environment of my sample firms. I do so by comparing the earnings management behavior of nonprofit hospitals to that of for-profit hospitals. Overall, results suggest that nonprofit managers strategically manage earnings higher when their firms are less vulnerable to regulator scrutiny of their reported chairy care. As such, my study contributes to the earnings management literature and has policy implications important to regulators, especially given the current U.S. healthcare environment.
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