Real earnings management and capital structure: Does environmental, social and governance (ESG) performance matter?

Abstract

This paper examines the impact of real earnings management (REM) on the capital structure of listed firms across ASEAN countries using the fixed effects panel data estimator for the period 2014–2019. Prior literature has focused primarily on aggregate real earnings management, overlooking the disaggregated sources of EM from real activities. It also investigates the role of environmental, social, and governance (ESG) performance on the impact of REM on leverage. We find that REM has a significant positive effect on leverage. It also finds that REM sourced from abnormal production costs and abnormal discretionary expenses have positive impacts on leverage. In contrast, abnormal cash flows from operating activities do not significantly influence leverage. On the role of ESG performance, we find that REM significantly and positively affects leverage in firms with low ESG performance and across ESG pillar scores. However, REM does not affect leverage in high- ESG performing firms, except for the governance pillar score. This suggests that ASEAN firms exhibit weak corporate governance as sustainable behaviours may not reduce the agency cost of debt. Our results are robust to a battery of tests. Our results have implications for the stakeholder theory in that it attenuates the agency costs of earnings manipulations.