Enterprise Risk Management Quality and Financial Distress Risk: A Real Earnings Perspective

Abstract

Motivated by the recent decline in performance and liquidity crisis of African firms orchestrated by the COVID-19 pandemic, this research examines the impact of real earnings management (REM) on financial distress risk (FDRisk), and whether enterprise risk management quality (ERMQ) moderates the effect. The study provides new insights on whether firms with robust enterprise risk management (ERM) systems performs better than their counterparts with no ERM systems. This research examines the impact of real earnings management (REM) on FDRisk, and whether ERMQ moderates the effect. The study employs the least square dummy (LSDV) variable two-way fixed effect estimator to analyse panel data from 186 non-financial firms operating in nine (9) sub-Saharan African countries. The findings indicate that REM worsens FDRisk. The results also suggest that firms that implement high-quality enterprise risk management attenuate the negative effect of REM on FDRisk. We further find that "board governance" and "corporate disclosure" quality are likely channels through which REM exacerbates FDRisk. This study offers an empirical explanation of how REM worsens FDRisk and the alleviating role of ERMQ, as corporations in weaker corporate governance (CG) regions seek strategies to discourage REM and improve firms' financial health.