Impact of earnings management on firm’s financial performance – evidence from India

Purpose This study aims to use different proxies to analyze the impact of earnings management (EM) on firm financial performance (FP). It provides empirical evidence from India, which is considered an emerging economy. Design/methodology/approach The sample represents the 704 nonfinancial firms on the Bombay Stock Exchange. With a 21-year period, the authors used the McNichols (2002) model to find discretionary accruals (DA); firm FP is captured through accounting-based (return on assets and earnings per rupee share capital) and market-based (Tobins_Q and PB_Ratio) measures and applied panel regression analysis using OLS, fixed effect and two-stage least square estimators. Findings Based on different estimators, the authors found that EM proxies positively impact the firm’s performance, confirming the application of agency theory to inflate the firm’s performance by managers. Research limitations/implications The present study uses a sample of nonfinancial firms, which becomes its limitation for the financial sector. Further, the study focuses on the financial aspect of performance, which becomes another limitation. Practical implications Investors, analysts and other stakeholders would be able to identify the firms that manage the earnings more than the industry average. The study findings would enhance policymakers’ willingness to prepare appropriate industry-specific regulations, which might improve Indian financial market efficiency and performance and reduce financial fraud among Indian firms. Originality/value To the best of the authors’ knowledge, this is the first study that suggests excessive accrual (E_DA) and standardized accruals (S_DA) as new discretionary accrual proxies for EM practices. Regarding EM, only a few good studies have been conducted for Indian firms, which creates ample opportunities for different types of research in this domain. The present paper tries to fill this research gap by concentrating on Indian firms.