Do Political Connections Mitigate the Detrimental Effect of Earnings Management? Evidence From Cost of Debt

This study investigates the conditional impact of political connections on the association between earnings management and the cost of debt. The underlying framework refers to resource dependence and agency perspectives. The sample consists of non-financial firms listed on the Indonesia Stock Exchange from 2010 to 2020. We find a positive relationship between earnings management and cost of debt. Political connections mitigate the adverse impact of earnings management by US$0.766 million in interest paid, consistent with the resource dependence perspective. Additional tests indicate that the mitigating effect of political connections is more pronounced in firms experiencing inferior financial performance, establishing connections to higher-ranking politicians, and securing debt solely from bank loans. Lastly, we document that debtholders are less likely to detect real operations-based earnings management in their lending assessments. Our findings are robust to alternative measure of earnings management and political connections and different estimation methods to address endogeneity concerns.