The Influence of earnings volatility on the relationship between leverage and classifications shifting earnings management: An Entrepreneurial view

Abstract

This study investigates the relationship between leverage and classifications shifting earnings management and how this relationship is influenced by earnings volatility. To achieve the research objective, this study takes the sample of Pakistani non-financial firms listed in Pakistan Stock Exchange for the period of 2004 to 2018. This study discusses the relationship between leverage and classifications shifting earnings management, especially with the interaction of earnings volatility. The study is supported with the Agency Theory and Positive Accounting Theory using the two-step system Generalized Method of Moment (SYS-GMM) dynamic panel estimators. The leverage is measured by using long term debt, short term debt and total debt while earnings volatility captured the measurement of business risk and for the measurement of classifications shifting is used as earnings management. To capture the classifications shifting, McVey model is used that measures the core earnings. Firstly, the study examines the relationship between leverage and classifications shifting earnings management and after that how earnings volatility influences that relationship. The results showed that relationship between classifications shifting and leverage and is positive but when an interaction term is used as earnings volatility it shows negative relationship between classifications shifting and leverage. So when the firm needs debt in the shape of leverage, it misclassifies the core earnings in the income statement but when there are fluctuations in the earnings like earnings volatility of firm it avoids to use classifications shifting due to professional assessment of the financial institutes and brokers of financial markets. So, in the entrepreneurial firms the managers avoid to use earnings management because these managers keep and show the true financial representations of financial statements.