Earnings management among distressed firms: evidence from India

Abstract

The rise in insolvency filings in India has drawn significant academic attention due to the high costs associated with financial distress. This study investigates the extent of earnings management by distressed firms in India, exploring factors like capital infusion, institutional ownership, regulation, and accounting flexibility. Earnings management is captured through three different proxies: accrual, real, and total earnings management. Financial distress is measured through three comprehensive definitions. Data spanning from 2008 to 2022 is collected, and panel fixed-effects regression is used for data analysis. The findings suggest that distressed firms tend to engage in earnings management through real earnings management, primarily via sales manipulations and overproduction. Earnings management is prevalent prior to new debt issuance but not before new equity issuance, and the presence of institutional investors effectively limits earnings management. Furthermore, companies resort to real earnings management when accrual earnings management is constrained by regulation and accounting flexibility.