Do Earnings Management Leads to Sub-optimal Investments by Firms? Empirical Evidence From the Textile Sector of Pakistan

Abstract

This study empirically investigates the impact of earnings management on investments of the firm. In this study, we also check the moderating role of audit quality between the above said relationship. We hypothesize that audit quality will not only weakens the relationship between earnings management and inefficient investments but also help the firm to invest reduction in over and under investments by the firm. Textile sector of Pakistan is selected for the study as it is one of the most important sectors of the country. The role of audit quality cannot be ignored to improve the information quality which ultimately helps the firm to make optimal decisions for the firm shareholders. The earning management activities are performed by firm managers due to moral hazard and adverse selection problem which leads to sub-optimal investments.