The Impact of Financial Leverage on Accrual-Based and Real Earnings Management

Abstract

The primary aim of this study is to examine the association between leverage and Real Earnings Management (REM) activities. It analyses how leverage is able to reduce earnings management (EM). This study uses Abnormal Cash Flow from Operation, Abnormal Production Cost and Abnormal Discretionary Expenses model by Roychowdhury, 2006, as a proxy for REM. Using a sample of 3,745 firm-year observations for the period of 2006-2011, which listed on Bursa Malaysia, the study find that a significant negative association between leverage and REM. The finding reveals that leveraged firms have lower levels of REM. This supports the view that leverage limits the REM activities, which in turn, could affect the quality of accounting earnings.