Corporate Earnings Management and Financing policy

In this study, we conduct an empirical analysis of whether the causal relationship between corporate earnings management and debt policy exists. Jensen (1986) and Harvey (2004) and others argue that firms increase debt levels, or leverage ratios, to reduce agency costs. This study hypothesizes that firms with higher earnings management increase their leverage ratios to reduce agent costs, assuming that the larger the firm's earnings management, the higher the agency costs. This study found that earnings management in Korean firms had a high positive correlation with debt policy, or leverage ratios. This is a result of supporting the agency cost hypothesis that Korean companies with larger earnings management are considered to have higher information asymmetry or agent costs, so that companies with large earnings management are adopting a debt policy that increases leverage ratios to reduce agent costs.