Using economic deregulation as a source of exogenous variation in product market competition, we find that firms engage in more earnings management and accounting frauds following deregulation. Further analyses reveal that the increase in earnings management is particularly pronounced for firms in high market‐to‐book industries. We find evidence of general short‐termism in the capital market, where firm values become increasingly sensitive to small earnings surprises in the post‐deregulation period, particularly in high market‐to‐book industries. We also show that firms in these industries that engage in active earnings management are more likely to survive in an increasingly competitive product market by making more acquisitions. The last two findings help explain the interactive effect of capital market valuation and product market competition on earnings manipulation.
Key words: Product market competition, economic deregulation, earnings management, corporate frauds, capital market valuation, shareholder short‐termism, acquisitions, firm survival
JEL Classification: G34, G38
