In this study, we examine how firms’ reliance on external capital affects their real earnings management (REM) practices. The sample comprises 366,065 firm-year observations from G20 nations over the period from 2003 to 2022. Our results reveal that firms reliant on external capital engage in REM activities. The findings also emphasize that early-stage enterprises, primarily financed with equity capital, indulge in REM activities. In addition, our heterogeneity analyses suggest that businesses in common-law countries utilize REM as a preferred choice for accrual-driven earnings management (AEM). This finding shows that stronger law enforcement in such countries increases the costs of AEM practices. Overall, the results demonstrate that REM practices are conditional on firms’ dependence on external finance, life-cycle stage, and the institutional context in which firms organize their operations. These findings remain consistent across several additional tests, including alternative REM metrics, different financing metrics, and alternative scaling methods. The findings provide significant implications for investors and regulatory institutions, who seek to enhance the quality of reporting practices. JEL Codes: G32, L25, M41
Mehra et al. (Mon,) studied this question.