The Moderating Effect of the Business Group Affiliation on the Relationship between Debt and Earnings Management

Abstract

Earnings quality is crucial to provide investors and lenders with accurate information about the economic health of the firm and to help them make the right decisions. This paper examines whether the pooling of financial resources and internal funds allocation in corporate groups has a positive effect on earnings quality through reduced earnings management practices in affiliated firms. It is hypothesized that the funding benefits of pooling financial resources in corporate groups allow affiliated firms to reduce solvency problems arising from higher leverage, which in turn reduces incentives for earnings management. The study is based on a balanced panel data set of 95 non-financial firms traded on Borsa Istanbul covering the period between 2015 and 2022 (8 years) with a total of 760 observations. Using management's discretionary accruals as a proxy variable to measure management's flexibility to engage in earnings management, this study finds that being affiliated to a business group reduces earnings management incentives in group affiliates when firm's leverage increases. The business group's support on the debt-leveraged firm alleviates the motivation for earnings management practices.