Real earnings management practices and financial performance: The moderating role of whistleblowing policy

Purpose This study revisits the relationship between real earnings management (REM) and financial performance (FP) and examines the moderating effect of the whistleblowing policy (WBP) on the REM-FP relationship. It further investigates the potential channels through which REM deters FP.Aim This study empirically tests whether the perceptual deterrence theory is relevant to the ongoing debates and variations in the relationship between real earnings management practices and financial performance.Design/Methodology/Approach The study utilises a panel data set of publicly quoted non-financial companies operating in twelve (12) sub-Saharan African countries from 2014 to 2020. It employs the disclosure of WBP in the corporate governance section of annual reports to gauge WBP, while REM is estimated using aggregated real earnings components (abnormal production costs, abnormal discretionary expenditures, and abnormal cash inflows).Main Findings The study finds that REM reduces FP. Findings also indicate that WBP mitigates the adverse impacts of REM on FP. This study further empirically documents that “agency costs,” “CEO integrity,” and “financial distress” are potential channels through which REM negatively impacts FP. Our results align with disaggregated measures of REM, sub-sample analysis, and considerations of endogeneity issues.Practical Implications Our findings suggest that corporate firms that implement a robust whistleblowing policy can deter REM practices and lessen negative market reactions. This policy promotes a culture of integrity and empowers employees to report financial misconduct without fear of retaliation, thereby enhancing transparency and reducing market volatility while improving operational efficiency and profitability.Novelty/Contribution This study presents a whistleblowing policy as a means of deterring REM practices through the theoretical lens of perceptual deterrence theory. It also contributes by documenting that agency costs, CEO integrity, and financial distress represent the channels through which REM practices negatively affect financial performance.