The impact of financial difficulties on earnings management strategies: The case of Italian non-listed firms

Matonti, Gaetano; Tommasetti, Aurelio; Torre, Carlo; Tucker, Jon

Abstract

This study investigates the impact of the degree of financial distress on the earnings management activities of Italian non-listed firms. The extant literature provides mixed evidence on this relationship for listed firms. We find a positive (negative) relationship between financial distress risk and income-decreasing (income-increasing) earnings management, suggesting that firms tend to manage earnings downward as financial distress risk (proxied by Altman's Z-Score) increases. Consistent with the Jensen control hypothesis, stressed firms are more likely to reveal their weak financial performance to stakeholders in order to renegotiate their debt on better terms and to signal the manager's willingness to deal with these problems to stakeholders (e.g. lenders and auditors). In two robustness tests, we test the power of the Kothari et al. (2005) model for decomposing total accruals and we also analyse a reduced firm sample representing over 80% of the population. We employ a linear regression model controlling for heteroschedasticity and autocorrelation using the Petersen method. The dependent variable is continuous and proxies negative discretionary accruals (DA) by setting positive (DA) to zero since we hypothesise that managers of distressed firms are more likely to manage earnings downward than healthy firms. Distress is proxied by the Altman Z-score measure for non-listed firms. Our research has several implications for academics, practitioners, lenders, and national standard setters, showing that, in

• Journal Article Type: Article
• Acceptance Date: Oct 29, 2020
• Publication Date: Nov 2, 2020
• Deposit Date: Jun 19, 2021
• Publicly Available Date: Jun 22, 2021
• Journal: African Journal of Business Management
• Print ISSN: 1990-3839
• Publisher: Academic Journals
• Peer Reviewed: Peer Reviewed
• Volume: 14
• Issue: 11
• Article Number: 28992BB65450
• Pages: 511-528
• DOI: https://doi.org/10.5897/AJBM2020.9105
• Public URL: https://uwe-repository.worktribe.com/output/6862148