earning management, a tool to manage cost of CAPITAL OF FIRMS: an empirical evidence from cement sector of psx

Abstract

Purpose Earning management is practice of manipulation of earnings to create a positive business outlook with the ultimate goal ofminimizing financial costs. This study examines the relationship between earning management and cost of capital while controlling for ROA, BtM and firm size, to analyze whethersuch practices accomplish the initial expectations oflowered cost of capital. Methodology & Design The paper targets the cement sector of Pakistan Stock Exchange. The data constitutes a cross section ofseven random firms ofthe sector from a total ofseventeen. The hypothesis ofthe study has been tested through statistical model of PEGLS auto regressive model with REM. For robustness check, another variable of DtE (financial risk measure) was added into the model as control variable. Findings The results show that discretionary accruals have a strong negative relationship with cost of capital (p = 0.0052) which goes on to become strongly positive (p = 0.0013) in three years’ time. The two respective iterations showed overall model significance of0.003896 and 0.052 which indicates that the control variables effectively controlled results while DA produced negative relationship with cost of capital, however, the control became weaker while producing positive relationship after three years due to importance oflagged effects. But the relationship between cost of capital and DA remained significant and became positive. Limitations The limitations ofthis study include possible ineffectiveness ofproxy selection for risk free rate as Pakistan is a developing economy and time constraint. Recommendations Managers should rethink their myopic behaviors related to reducing costs. Investors should understand the impact oftheir behaviors on firms and capital market. Lastly, researchers are recommended to use alternative proxies and perform research in different settings to understand the dynamics ofnature ofstudied variables.