IMPACT OF FINANCIAL DISTRESS ON EARNINGS MANAGEMENTAND MODERATING ROLE OF INTERNAL QUALITY: EVIDENCE FROM PAKISTAN

Abstract

This study investigates the effect of financial distress (FD) on real earnings management (REM) in non-financial firms listed in Pakistan with an emphasis on the moderating role of internal controls (IC). A fixed effects model is used to test the hypotheses using data from non-financial firms registered on the Pakistan Stock Exchange (PSX). The study sample consist of secondary data from year 2018 to 2022 and nature of data is panel data. The Altman Z-Score model is used for the calculating of FD, whilst proxies like abnormal cash flows cash flows, discretionary expenses, and production costs is used to measure REM. The study additionally add control variables such as return on assets, firm size, and current ratio. However FD is independent variable while REM is dependent variable. The findings indicate that FD and REM have a negative but statistically significant relationship, which may indicate that financially troubled enterprises participate in less REM. But when internal controls were taken into account, audit quality had a negligible moderating effect, suggesting that strong internal controls might not be enough to stop REM in financial distress companies.