The governance involvement in the relationship between earnings management and surplus free cash flow

Abstract

The purpose of this study is to examine empirically the association between surplus free cash flow (SFCF) and earnings management (EM), and the moderating effect of governance on this relationship. The study used a sample of non-financial companies listed on the Amman Stock Exchange (ASE) over the ten-year period (2011–2020) with all the information necessary to estimate the study variables. The modified Jones (1991) model is used to estimate discretionary accruals, a widely used proxy for earnings management. Based on the regression analysis of the related panel data collected, the study’s findings indicate that SFCF is positively associated with EM activities. This result is consistent with most prior related study’s findings (Nouri & Gilaninia, 2017; Rahmawati, 2020) and suggests that when growth opportunities are limited, the free cash flow induces management to involve in upward management practices. Additionally, results indicate a significant negative impact of the interaction variable SFCF*AQ (audit quality) on EM, suggesting that, in an SFCF situation, AQ reduces manager’s tendency to involve in upward EM practices. The study’s results are likely to be useful for accounting researchers, local governmental bodies, and policymakers who are concern with the impact of EM practices on the quality of earnings.