Financial Distress, Earnings Management, and the moderated role of Audit Quality: Evidence from East African Countries

Abstract

Abstract

This study contributes to the current literature by providing further evidence of the relationship between financial distress and earnings management for the listed firms during economic shocks. In addition, it extends the existing literature by investigating the moderated role of audit quality in the association between financial distress and earnings management. Using the unique data set of the East African listed firms, the study analyses 303 firm-year observations of distressed firms from 2009 to 2019. Financial distress as an independent variable was measured by using the Attman Z-score. Moreover, accrued and real earnings management as dependent variables were measured using the modified Jones model and Roychowdhury model, respectively, while audit quality was measured using audit fees. The finding suggests that financial distress is negatively related to accrued-based and real earnings management. The finding also shows that audit quality moderates the impact of financial distress on real earnings management but not accrued earnings management. The finding has practical implications for shareholders, policymakers and auditors to design appropriate measures that can help to reduce the impact of financial Distress on EAC-listed firms.

Keywords: Financial Distress, Earnings management, Accrued Earning Management, Real Earnings Management, Developing Countries and Audit Quality