Financial Distress and Earnings Management: Evidence from Sri Lanka

Abstract

This research's main intention is to scrutinise the impact of financial distress on earnings management in selected Sri Lankan listed firms. This study's sample covers two hundred and seven companies listed on the Colombo Stock Exchange (CSE), excluding the financial sector companies, which were chosen based on the availability of data from 2013 to 2017. Earnings management is approximated based on two strategies: accrual earnings management and real earnings management. The Modified Jones model developed by Dechow, Sloan, and Sweeney (1995) is used to calculate the measure of accruals earnings management. The Roychowdhury (2006) developed combined models of abnormal production costs and abnormal discretionary expenditures are used to assess the amount of real earnings management.The study outcomes indicated that financial distress is positively related to accrual earnings management while being negatively associated with the magnitude of real earnings management. This report's denouement offers greater comprehension for financial practitioners to make optimum financial choices.