The Relationship between Financing Policy, Earnings Management and Governance Practices

Abstract

This paper examines the effect of managers manipulated earnings management methods on the firm’s financing policies and investigates the relationship between internal control, audit quality, and earnings management. We adopt the two-stage model to control self-selection of earnings management and the principal component analysis to extract the first principal component as the corporate governance. The findings show that firms choose the earning management tools in advance in year -1. Corporate governance can restrain real earnings management, but the effect decline when firms engaged in financing activities. Only the larger shareholdings of institutional investors and firms audited by industry specialist can restrain real earnings management when firms undertake financing policies. The firms of issuing bonds choose real earnings management to avoid frequent outsider monitoring. And then, it causes operating performance to decline continuously two years after bond financing. Moreover, investors don’t correct the price impact of earlier earnings overstates for SEOs and bonds sample.