The Influence of Cash Flows Volatility on The Relationship Between Leverage and Accruals Earnings Management

Abstract

This study examines how cash flow volatility affects leverage and accruals earnings management. The research objective achieves by analyzing a sample of non-financial Pakistani enterprises from 2004 to 2018. The paper examines leverage and earnings management in business risk, specifically cash flow volatility. The leverage includes short term, long term, and total debt, while cash flows volatility is used as business risk. The earnings management level is measured by accruals earnings management also by using John Modified Model that suggests measuring earnings management approach by using discretionary accruals. This analysis uses agency and positive accounting theory. This study uses two-step system Generalized Method of Moment (SYS-GMM) dynamic panel estimators to examine leverage and earnings management. The study also examines how business risk affects this relationship for Pakistani enterprises. Endogeneity between variables motivates the adoption of SYS-GMM. The study found that leveraged managers use accruals earnings management. Leverage and accruals earnings management are positively correlated. The firm managers deliberately eschew accruals-based earnings management and leverage long-term debt. This choice is predicated on the unfavorable link between long-term debt and accruals earnings management. The leverage impacts negatively on accruals earnings management in the presence of cash flows volatility that discourage the managers to manipulate the financial statements. When seeking external finance, managers are less likely to use accruals-based earnings management when facing cash flow instability.