Diversification Strategy and Earnings Management: An Empirical Investigation of Firms in Manufacturing Sector

Abstract

The present study examines the link between diversification strategies and earnings management for firms operating in manufacturing sector. Diversification strategies include expansion across market (international diversification) and product segments (product diversification). The sample derived for the period 2004 to 2013 includes business groups affiliated firms and standalone firms. Several firm-specific factors are included in the model. Agency cost and business risk variables are included to understand the applicability of information asymmetry hypothesis and earnings volatility hypothesis. Both univariate analysis (mean comparison) and multivariate analysis (panel data regression) is employed. The empirical analysis shows that for the overall sample product diversification enhances the practice of earnings management. Similar finding is found for international firms within business group. This shows that international diversification as such does not increases earnings management however diversification across product segment provide favorable condition for managing earnings thus reducing the quality of reported earnings. Sub sample analysis reveals that agency cost is having a significant negative relationship with earnings management indicating that higher informational asymmetry is not conductive to the practice of earnings management.