Using a sample of approximately 87,000 earnings observations from almost 22,000 firms in 18 countries for the five‐year period 1995–1999, we document firms' tendency to exercise cosmetic earnings management (CEM) worldwide. Following prior studies in the area (Thomas 1989, among others), we define CEM by small upward rounding of reported net income that generates more than expected zeros and less than expected nines as second digit of earnings numbers. We partition our sample into positive and negative earnings to see whether the anomalous frequencies are reversed in negative earnings (losses) relative to positive earnings (profits), as predicted by CEM. In addition, we analyze net sales as a control variable. We find that, due to more ample opportunities to accounting manipulation, upward rounding is much more significant on the bottom line than on the top of an income statement. Consistent with prior studies, we find a reversed pattern of CEM for net losses. In addition, we find evidence for our expectation that CEM covaries with some institutional factors. We report that CEM decreases with spending on auditing, whereas it increases with the latitude of country's GAAP, its cultural values (power distance), and the importance of management bonus schemes. Contrary to our expectation, we do not find significant relationships between CEM and some factors commonly considered in related recent studies, such as the degree of shareholder protection or the alignment of financial and tax accounting.
