The impact of real earnings management on corporate credit risk

Abstract

PurposeEarnings management (EM) plays a vital role in risk management. This paper aims to investigate the impact of real earning management (REM) on credit risk.Design/methodology/approachThis paper measures the credit risk by the expected default frequency of Kealhofer, McQuown and Vasicek model. This paper uses data from 2011 to 2020 of Pakistani manufacturing listed firms. This paper applies the fixed effect to analyze the results and generalized methods of moments to handle the heterogeneity issue.FindingsThis paper finds that the impact of REM on corporate credit risk is positive and significant and that of sales manipulation is negative and significant. This paper also reports similar outcomes of the robustness test using dynamic panel regression.Originality/valueThe findings of this study may help managers to modify the EM strategy to minimize corporate credit risk. Furthermore, the findings of this study are important for investors to enhance their understanding of firms’ accounting information, REM activities and cash flow patterns. It further suggests the manager should consider credit risk as an important factor while practicing REM.