Financial distress as a driver of accrual earnings management: insights from South Africa’s JSE-listed firms

This study examines the impact of financial distress on earnings management (AEM) in Johannesburg Stock Exchange (JSE)-listed firms from 2013 to 2023. A sample of 173 non-financial firms is used. The Kothari performance-matched modified Jones model estimates discretionary accruals. The De la Rey K-Score model measures financial distress, while the Ohlson O-Score and binary measures are used for robustness. The analysis is conducted using Canay’s two-step fixed effects quantile regression model and Driscoll-Kraay standard errors to control for unobserved heterogeneity, heteroskedasticity, and cross-sectional dependence. Findings show that financial distress has a positive, statistically significant relationship with AEM when measured by the continuous K-Score, especially at the median and upper quantiles, suggesting that distressed firms adjust accruals to appear stable. In contrast, binary distress measures show a negative association, consistent with more conservative reporting under severe distress, while the O-Score has lower explanatory power. The results underscore the need for regulators, policymakers, and standard-setting organizations to enhance frameworks for identifying and preventing opportunistic accrual practices by financially distressed companies. The study confirms that the K-Score is a context-sensitive indicator of financial distress and shows that the relationship between financial distress and accrual manipulation is non-linear.