Enforcement of Accounting Standards: How Effective is the German Two-Tier System in Detecting Earnings Management?

Within the European Union, the IAS-Regulation has harmonized applicable accounting standards for consolidated financial statements of capital market oriented companies by requiring IFRS since 2005. Regarding enforcement of financial reporting, the IAS-Regulation offered only small guidance for EU member states which led to the implementation of different enforcement systems. Currently, harmonization efforts are taken, in particular by the European Securities and Markets Authority, to establish a cross-jurisdictional accounting enforcement regime. This paper contributes to the discussion of standardized EU-wide enforcement mechanisms by assessing the effectiveness of the current German two-tier enforcement system in detecting earnings management. Using a unique data set provided by the German capital market authority, we find that the German enforcement system is effective in detecting earnings management, but shows weak ability in constraining earnings management in years following error releases.