Earnings management by family firms to meet the debt covenants: evidence from India

Avabruth, Suhas M.; Padhi, Subha Kant

doi:10.1108/jaee-12-2020-0331

Cited by 8 publications

(14 citation statements)

References 83 publications

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“…Previous studies have shown that managers incur personal consequences after covenant violations, such as more forced CEO turnover (Ozelge and Saunders, 2012). Many studies have found that companies use accrual earnings management (AEM) and real earnings management (REM) to prevent violating income statement and balance sheet covenants for the same reason (Jha, 2013; Franz et al , 2014; Kim et al , 2017; Ater and Hansen, 2020; Avabruth and Padhi, 2023; Dyreng et al , 2022).…”

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

“…Due to many factors, credit markets are likely to encourage managers to engage in categorization shifting. Financial goals, such as debt-to-equity ratios or interest coverage ratios, are frequently included in debt covenants (Avabruth and Padhi, 2023). Management may falsify financial statements and accomplish these goals by engaging in classification shifting, which can assist the company in avoiding default and maintaining access to credit markets.…”

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

“…Debt covenant violations can have serious repercussions for businesses, including higher borrowing rates, restricted credit availability and potential default (Beneish and Press, 1993). Companies use earnings management techniques to manipulate their financial statements and fulfill covenant requirements to avoid such negative effects (Jaggi and Lee, 2002; Jha, 2013; HassabElnaby et al , 2017; Dyreng et al , 2022; Avabruth and Padhi, 2023).…”

Section: Introductionmentioning

confidence: 99%

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Do credit market incentives drive classification shifting in emerging markets?

Bansal

2023

IJAIM

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Purpose To report inflated operating performance indicators, such as operating revenue and operating profit, managers vertically reposition revenue and expense items inside the income statement. This study aims to investigate the relationship between credit market incentives and these practices. Design/methodology/approach This study examined a sample of 1,592 Bombay Stock Exchange-listed companies from 2009 to 2021 and tested them using panel data regression models. The propensity score matching method and different measurements of classification shifting practices are used to validate the results. Findings The conclusions drawn from the empirical data show that firms prefer revenue shifting over expense shifting to prevent debt covenant violations. It shows that the firm’s classification-shifting practices are driven by credit market incentives. This finding is consistent with the notion of positive accounting theory that firms engage in classification shifting (earnings management) to avoid violation of debt covenants. Further, the firm’s preference for revenue shifting is in line with the ease-need-advantage-based shifting framework where firms choose the shifting tool based on costs and constraints associated with each tool. Practical implications The finding suggests that if managers heavily rely on revenue shifting to avoid debt covenant violations, the firm may end up breaking these covenants based on its actual operating performance. Managers may use aggressive accounting techniques to prevent covenant violations, which can be a warning indicator of financial difficulties or operational problems. It highlights the necessity for creditors and investors to carefully evaluate a company’s financial stability outside of the financial statements that are publicly disclosed. Authorities should create separate forensic accounting standards for auditors to check revenue items and stop the corporate misfeasance of revenue shifting. Originality/value The study is among the earlier attempts to provide empirical evidence on credit market incentives behind classification shifting practices. It is the first study that documents the substitution relationship between classification shifting forms for avoiding violation of debt covenants.

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Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

Section: Literature Review and Hypothesis Developmentmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Do credit market incentives drive classification shifting in emerging markets?

Bansal

2023

IJAIM

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“…, 2012). Drawing on the same tenets, several studies found that firms engage in accrual earnings management (AEM) [1] and real earnings management (REM) [2] to avoid the violation of income statement and balance sheet-based covenants (for instance, DeFond and Jiambalvo, 1994; Jaggi and Lee, 2002; Chamberlain et al ., 2014; Franz et al ., 2014; Kim et al ., 2017; Ater and Hansen, 2020; Avabruth and Padhi, 2023; Dyreng et al ., 2022).…”

Section: Introductionmentioning

confidence: 99%

“…We examine our research questions under Indian institutional settings because bank debt is the main source of borrowing in India (Allen et al ., 2012), where EBITDA and sales-based covenants are the most commonly used covenants (Avabruth and Padhi, 2023). Based on the sample of Bombay Stock Exchange (BSE)-listed firms spanning over thirteen years from March 2009 to March 2021, we find that firms prefer revenue shifting over expense shifting to avoid the violation of debt covenants.…”

Section: Introductionmentioning

confidence: 99%

Debt covenants and classification shifting: moderating role of audit quality

Bansal

2023

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PurposeThe study aims to investigates which form of classification shifting is preferred by firms to avoid the violation of debt covenants and whether the higher-audit quality constraints the shifting practices of firms incentivized to avoid covenant violations or not.Design/methodology/approachA sample of 1,644 Bombay Stock Exchange (BSE)-listed firms during the period 2009–2021 has been used in this study and tested through panel data regression models. Two forms of classification shifting, namely expense shifting and revenue shifting have been taken into account. The findings are validated through the propensity-score matching technique.FindingsThe findings deduced from the empirical evidence demonstrate that firms prefer revenue shifting over expense shifting to avoid covenant violations, consistent with the notion of the ease-need-advantage-based shifting framework, where firms are found to prefer a shifting tool with greater relative advantage. Further, the author finds that superior audit quality has a constraining effect on expense shifting, but not on revenue shifting, indicating the partial effectiveness of high-quality auditors in curbing the corporate misfeasance of classification shifting. These results are robust to the problem of endogeneity and self-selection bias.Originality/valueThe paper provides new evidence on debt market incentives behind classification shifting, where firms are found to substitute classification shifting forms to avoid covenant violations. Further, the study is among pioneering attempts to investigate the impact of audit quality on revenue shifting and document the non-constraining effect.

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Damaging Behavior Directed Outside the Family Firm

Kidwell

2024

Dysfunction and Deviance Across Family Firms

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Earnings management by family firms to meet the debt covenants: evidence from India

Cited by 8 publications

References 83 publications

Do credit market incentives drive classification shifting in emerging markets?

Do credit market incentives drive classification shifting in emerging markets?

Debt covenants and classification shifting: moderating role of audit quality

Damaging Behavior Directed Outside the Family Firm

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