Factors Affecting the Earnings Management Practices in India

Abstract

There is hardly a day on which we do not get any news of account manipulation, banking fraud, bankruptcy, insolvency and leading/large firms misleading investors by using discretion in reporting. The definition of a ‘true and fair view’ of the financial position disclosed by the firms is continuously under debate. The provisions of Generally Accepted Accounting Principles (GAAP) are being used at managerial discretion. These discretionary practices are called ‘Earnings Management (EM)’. This practice is followed by managers to reduce agency conflict among managers and shareholders or between controlling shareholders and minority shareholders. This affects the earnings quality of the firms in India. As a solution, researchers have developed some measures to detect earnings management. The main aim of this study is to find the inter-relationship among the measures of earnings management and to examine the impact of financiers, the board of directors and the exposure to the stock market. The role of financiers is measured by two variables: total debt amount and bank debt amount. Board size and board independence represent the impact of the board, while the listing status and International Financial Reporting Standards (IFRS) adoption measure the exposure a firm gets. The sample for the study is selected from Indian nonfinancial firms, which include the Food and Agriculture-Based industry and Mining industries. These industries represent the primary sector of the economy and contribute to the economy to a great extent. The data has been collected from the Prowess database of the Centre for Monitoring Indian Economy (CMIE), financial reports of the firms, various reports published by the Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI) and the Ministry of Corporate Affairs (MCA). The data has been processed for 1818 firms for the period of 2002-2022, after excluding the firms that do not have complete balance sheet data for at least five years. The numbers which do not support the basic accounting equation and the outliers are removed. Hence, 18672 firm-years are included in the final sample. However, some observations were removed while doing regression analysis with list-wise exclusion of missing data. First, discretionary accruals are estimated crosssectionally for each industry sub-sector, using ten different models of earnings management. Then all the measures are compared through different statistical tools and found to be consistent with each other. The absolute value of discretionary accrual estimated by the modified Jones (1991) model is used for further analysis. The impact of the variables is examined by using the Least Square Dummy Variable Regression model. The results depict a significant impact of bank loans on reducing earnings management while the level of earnings management increases with increased borrowings from outsiders. The board has an insignificant impact on earnings management. It is seen that earnings management is practised more in un-listed firms than in listed firms. But, implementing IFRS has no significant effect on EM behaviour in India. The major contributions of the study are - a) attempting three new measures of earnings management inspired by previous researcher criticism on EM measures, b) studying the perspective of of both banking and non-banking lenders, c) exploring the effect of exposure a firm gets by adopting IFRS and from stock exchange regulations. The study has various theoretical and practical implications for fraud detection, improving board quality, supervision on adopting accounting standards, and efficient implementation of strict policies.