The influence of financial leverage on accrual-based earnings management: insights from listed Indian firms

Purpose This study investigates the relationship between leverage and accrual-based earnings management (AEM) in India. It further examines how leverage affects upward and downward AEM. Design/methodology/approach The study employs a system generalized method of moments (SGMM) model for estimation, using a dataset comprising 3,739 non-financial firms listed on the Bombay Stock Exchange over a 21-year period from 2002 to 2022. Besides the primary analysis, the study also conducts additional analysis by grouping the sample firms based on firm size, business group affiliation and macroeconomic condition (pre- versus post-financial crisis). Findings The results indicate that firms with higher leverage exhibit stronger incentives for engaging in AEM. Specifically, highly leveraged firms are more likely to engage in upward AEM and less likely to adopt downward AEM to project stronger financial performance and avoid violating debt covenants. The findings remain consistent across various contexts and robustness checks. Research limitations/implications The findings contribute to a deeper understanding of the managerial incentives arising from capital structure decisions in shaping financial reporting practices in emerging economies. Originality/value To the best of the authors’ knowledge, this is the first study to comprehensively examine the impact of leverage on both income-increasing and income-decreasing AEM in India.