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This study examines whether drug makers took political and earnings management actions in response to the 2008 presidential campaign, which proposed major healthcare reforms. Specifically, we draw from the political cost theory and examine whether the level of political spending and the behavior of abnormal accruals and discretionary expense items in 2008 are consistent with a strategy by the drug makers to avert or reduce the adverse effect of any such reforms. A supplementary analysis considers whether the firms differ in their responses to the proposed reforms as a function of their exposure to the expected wave of patent expirations and preexisting market conditions. In particular, we examine a subset of pharmaceutical firms with elevated exposure to patent expirations or with severe market valuation problems and test the proposition that such firms will be less inclined to manage earnings downward for fear of a greater stock market penalty. We document above average increases in political spending and abnormal decreases in discretionary accruals for the drug firms in 2008; however, the subset of firms with elevated exposure to the patent expirations or with underperforming stocks had significantly smaller income-decreasing accruals during the same period. These latter results demonstrate the increased sensitivity of the subsets of firms to the capital market costs associated with managing earnings downward.
