To investigate the rationalization of financial misreporting, we examine the effects
of an externally caused bad environment on misreporting and entitlement.
We conduct a 2x2 between-subjects experiment, manipulating the environmental
state and the awareness of those environmental states. We predict and find that a
bad environmental state causes a higher rate and a higher degree of misreporting.
This effect occurs due to a greater sense of entitlement among participants in response
to a bad environmental state. We also show that this effect vanishes if managers
are unaware of other environmental states. As managers cannot blame the
bad environmental state when they are not aware of better environmental states,
the sense of entitlement is lower. As a result, a bad environmental state does not
cause a higher rate and a higher degree of misreporting if managers are unaware
of other states.