The fine line between strategy and manipulation: Unraveling bankruptcy risk in the emerging market

This research presents a novel analysis of the intricate interrelationships among Porter’s (1980) business strategy — cost leadership and differentiation — and two forms of earnings management (accrual-based and real) and their impact on bankruptcy risk within publicly traded companies in Indonesia. Unlike previous research that predominantly concentrates on the accumulated method of accrual-based earnings management (AEM), this research enhances the discourse by exploring the influence of real earnings management (REM) on bankruptcy risk, especially in a developing nation where regulatory oversight and financial reporting transparency are less critical. This research analyzes a dataset of 756 company-year observations, using a fixed-effect model with clustered standard errors and generalized least squares (GLS) weighting and a two-stage least squares (2SLS) approach to enhance robustness. The results indicate that although AEM does not significantly impact bankruptcy risk, REM, mainly through sales manipulation and overproduction, is pivotal in influencing a firm’s financial outcomes and stability. Moreover, cost leadership and differentiation strategies significantly reduce the threat of financial failure. These results support Porter’s (1980) framework of competitive advantage theory and empirical findings by Xu et al. (2021) and Zang (2012), highlighting the importance of aligning earnings management practices and strategic direction to maintain financial stability.