Relationship between earnings management and corporate risk in Latin-American firms

Abstract

PurposeThe purpose of this article is to analyze the effects of accruals-based earnings management (AEM) and institutional and financial development on corporate risk of Latin-American firms.Design/methodology/approachThe GMM estimator was used according to Arellano and Bond (1991) for panel data on a sample of 914 non-financial companies between 2005 and 2017.FindingsAEM practices significantly increase corporate risk. This result indicates that the risk increase is associated to weakening of the corporate governance of companies. Positive discretionary accruals also have the same impact on corporate risk. In addition, accrual-based earnings management has a non-linear impact on corporate risk. Higher institutional and financial development systemically reduces the risk of Latin American firms. Institutional development can mitigate the effects of earnings management on corporate risk.Originality/valueThese results support that AEM represents a practice that managers use to weaken firms' corporate governance and expropriate wealth from shareholders. These practices promote higher firm's risk. However, the institutional and financial development reduces the corporate risk and contributes to mitigate the impact of AEM on it. These results have relevant implications for firms' corporate governance because they warn the relevance to control AEM practices and its impact over corporate risk perception by investors. These results also are relevant to policymakers because they orient the financial policies design to strengthen the institutional and financial development as a systematic way to reduce the firm's risk.