Financial distress, earnings management and Big 4 auditors in emerging markets

Abstract

Purpose The purpose of this study is to examine the association between financial distress and accruals-based earnings management in emerging markets, and the role that auditors play in that association. Design/methodology/approach This study relies on a sample of 33,455 firm-year observations from 20 emerging markets, covering a large period of analysis of 20 years. A multivariate analysis is performed by considering the level of financial distress as the dependent variable, and the accruals-based earnings management and dummies for the type of auditor as the main independent ones. Findings The authors predict and find empirical evidence that firms facing greater financial distress engage in income-increasing accruals-based earnings management in emerging markets, and that such engagement is lower in firms audited by Big 4 firms compared to those audited by non-Big 4 auditors. The authors also find significant differences across Big 4 audit firms in their role of constraining income-increasing earnings management strategies in firms with high levels of financial distress. Originality/value The study adds to previous literature by investigating the association between financial distress and accruals-based earnings management in a comprehensive sample of 20 emerging markets, by providing important overall cross-country empirical evidence that has not been addressed by previous literature. The authors also bring new knowledge by discussing the role played by the Big 4 audit firms in limiting earnings management practices by firms with high levels of financial distress. Such a limitation serves as an important external corporate governance mechanism to restrain managers’ opportunistic behaviour in firms facing financial distress – especially in emerging economies characterized overall by institutional voids.

Political–economic instability and earnings management in an emerging market: the case of the 2016 Presidential Impeachment in Brazil

“…Therefore, taking our results as a whole, we find an improvement in the quality of the information reported by firms in periods of marked political and economic instability. In this sense, although in general emerging economies are characterized by lower levels of enforcement, higher levels of volatility and greater informality – which generally encourage earnings management practices in these countries (Viana et al. , 2022a) – our results suggest a decrease in this opportunistic practice during periods of greater uncertainty and political and economic imbalances.…”

“…Economic growth and political stability are profoundly interconnected and important factors for societies' welfare (Hussain, 2014). This matter seems even more relevant in emerging market countries (Viana et al. , 2022a, b), where investors face greater information asymmetry (Martins and Barros, 2021).…”

Institutional ownership, earnings management and earnings surprises: evidence from 39 years of U.S. data

“…Finally, research shows that larger auditors provide better quality audits (Becker et al. , 1998; DeAngelo, 1981; Lennox, 1999; Viana et al. , 2022).…”

Effects of Board Characteristics on Accruals Earnings Management in the Wake of Financial Crisis

“…The model below is used to test the hypotheses of the study: High-quality auditors contribute to lessen earnings management and also affect the construction of firms' internal control (Becker et al, 1998). Viana et al (2022) found that while a firm's level of financial distress positively affects accrual-based earnings management, this effect is weaker for firms audited by a Big 4 audit firm. Therefore, a variable for the audit firm was included in the model expecting a negative effect on earnings management.…”