Indirect Effect of Earnings Quality in the Linkage between Managerial Ability and Firm Performance: Evidence from an Emerging Economy

Abstract

Purpose: This paper investigates the associations among managerial ability (MA), earnings quality (EQ) and financial performance of the firm (FP) in the context of Pakistani economy.  Design/methodology/approach: For testing objectives, the research proposed panel data model based on three earnings quality attributes, such as predictability, smoothness, and conservatism, between the managerial ability and corporate financial performance. For estimation, the study analyzed an unbalanced panel of 219 non-financial listed firms on the Pakistan Stock Exchange (PSX) for 2008-2021. To address the concerns of heteroscedasticity and autocorrelation, the study applied fixed effect regression with robust standard errors clustered at the firm level, as suggested by Newey and West (1987). Findings: -The study provides that overall managerial ability enhances earnings quality and firm performance. In addition, it is observed that earnings quality plays a significant role in enhancing the firm financial performance. Furthermore, the findings also indicate that earnings quality partially mediates the linkage between managerial ability and firm performance. These results support the hypothesis that efficient managers enhance the earnings quality, reduce information asymmetries which translates into higher firm performance. Research limitations/implications:  The current research is limited to the non-financial sector; however, the study findings are undeniably beneficial for corporate managers in the context of developing economies where the managerial skills, quality of earnings and regulatory control is poor. Originality/value: -The novelty of the study lies in the managerial ability and performance linkage considering earning quality as a mediator. Standard-setters and regulators can use the study's findings to understand how managerial skills affect corporate practices, accounting standards and behaviour.