Earnings management and the informational and disciplining role of debt: evidence from Iran

Abstract

Purpose The agency theory predicts that there are conflict of interests between managers and shareholders over free cash flow and major operating decisions. Earnings management can help managers hide and retain their private benefits of control. Given that, the purpose of this study is to investigate whether financial leverage reduces agency and information problems caused by earnings management. Design/methodology/approach The research uses a sample of annual data of 200 firms listed on the Tehran Stock Exchange during 2002-2016. The data required is obtained from the Rahavard Novin database. The research uses multivariate regression models that regress financial leverage on earnings management proxies and other determinants of capital structure. Findings The research documents that firms with higher income smoothing and the absolute value of discretionary accruals, as the proxies for earnings management, have higher financial leverage. The results suggest that a higher level of financial leverage can discipline managers and generate useful information about firm quality. Originality/value The study highlights the informational and disciplining role of debt in the presence of severe uncertainty about firm quality in a developing country.

Bank loan information and information asymmetry in the stock market: evidence from China

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