Impact of duration of performance shortfall on real earnings management: a threat rigidity perspective

Purpose The authors examine whether the duration of performance shortfall in the firm impacts the real earnings management. Design/methodology/approach We find the results in the context of India, an emerging market, on a large sample set of 15,011 firm-year observations during 2006–2020. Findings We find that when managers continue to face short-term performance pressures, they shift their focus away from aspirational levels, prefer not to engage in strategic actions to address performance shortfalls and engage in opaque actions of real earnings management. We discover that this baseline relationship for business group-affiliated firms is stronger; however, the moderation effect is weaker under stronger corporate governance and the involvement of high-quality auditors. Practical implications The study suggests that the governing council of firms, such as the board of directors, must pay additional attention to underperforming firms, as a longer duration of performance shortfall may induce firms to engage in earnings management, which is detrimental to the long-term viability of organizations. Government authorities should pay close attention to the choices made by managers, especially when their performance is subpar. Furthermore, the government has the option to implement policies or offer financial assistance, such as special funds, to incentivize companies to refrain from participating in manipulation activities. Originality/value This is the first study to examine corporate misconduct through the lens of the “threat rigidity hypothesis,” which has significant implications for the management literature.