How does real earnings management affect firms’ future profitability? Evidence from Jordan

Abstract

This paper investigates the effects of the lagged real earnings management on the firms’ future profitability using a panel dataset (for the years 2012–2017) from the Jordanian industrial companies listed in the Amman Stock Exchange (ASE). We follow Roychowdhury (2006) to measure real earnings management using two proxies: abnormal sales (REMS) and abnormal production (REMP) in the regression analysis. Our findings reveal that real earnings management through abnormal sales has an insignificant effect on the firms’ future profitability. However, we document evidence that firms’ future profitability is adversely and significantly affected by real earnings management through abnormal production. We contribute to the ongoing debate in the literature of real earnings management and its ramifications on firms’ profitability, specifically in the context of developing countries. This research provides implications for policymakers, investors and managers regarding the potential consequences of channel stuffing practices at the different stages of the supply chain on the firm’s future profitability. Future research is suggested to focus on how real earnings management can possibly disrupt supply chains.