The influence of leverage on accrual-based and real earnings management: Evidence from the UK

Abstract

The crucial aim of this study is to observe the association between leverage and earnings management using accrual-based earnings management (AEM) and real earnings management (REM) practices among the firms listed on the London Stock Exchange. To keep unobservable elements under control, this study employs a Two-Stage Least Squares approach to analyse data from UK-listed firms for the years 2009-2020. The findings reveal that there is a significant negative association between leverage and earnings management through REM but not through AEM. The results are aligned with the premise that leverage works towards limiting REM activities, which eventually influences the accounting earnings quality. Therefore, high leverage calls for debt repayment to minimise the available cash for management’s non-optimal spending, depending on the lender-induced spending limitations. Further, this is predicted to minimise managers’ opportunistic behaviours and encourage their conservativeness. The study findings have implications for the regulatory and stock market players as it provides in-depth information concerning current practices in accounting and reporting.

Keywords

• Real earnings management
• Accrual- based earnings management
• Leverage
• Agency theory