Effect of Real Earnings Management on Firm Performance: Evidence from India

Abstract

This study investigates the effect of real earnings management (REM) on firms’ future performance in India. The sample comprises a balanced panel of 108 non-financial firms belonging to 21 industries (as per the two-digit NIC classification code) from 2006 to 2018. The proxy for REM given by Roychowdhury (2006) is used to measure REM, and the firm’s performance is measured through return on assets (ROA), return on equity (ROE) and price-to-earnings (PE) ratio. While ROA and ROE are measures of accounting performance, PE captures market performance. To explore the impact of REM activities on firms’ future performance, a Generalized method of moments (GMM) estimator is used in a dynamic panel setting. Since the proxy variables for performance is measured on a lead year basis, the analysis is restricted to the period 2006–2017. We also control for firm size, financial stability and growth. Our research reflects that Indian firms usually manipulate earnings by reducing discretionary expenditures. Regression results indicate that REM activities affect both accounting and market performance negatively.