ROLE OF CORPORATE GOVERNANCE IN EARNINGS MANAGEMENT

Abstract

Earnings management remains a central focus of academic inquiry and regulatory concern, particularly in emerging markets, where evolving governance mechanisms and institutional frameworks shape managerial discretion in financial reporting. The extraordinary disruption caused by the COVID-19 pandemic has heightened academic attention toward examining how firms adjust their reporting behaviour during periods of crisis. Unlike conventional financial or economic downturns, the COVID-19 crisis originated from non-economic sources yet resulted in widespread disruptions to production, supply chains, demand cycles, and capital markets. This unique context has raised significant questions about the incentives, opportunities, and constraints influencing earnings management practices during periods of extreme uncertainty. Prior empirical evidence offers mixed conclusions: while several studies document increased manipulation as firms attempt to portray distress or manage contractual pressures, others observe improved earnings quality driven by heightened monitoring, relaxed investor expectations, and elevated litigation risks. Against this backdrop, the present study provides an integrated examination of how corporate governance, audit quality, promoter ownership, firm-level cost determinants, and regulatory reforms interact to influence both accrual-based earnings management and real earnings management in India. The study is motivated by the distinctive characteristics of the Indian corporate structure, where concentrated promoter ownership, family-led management, and less stringent enforcement environments create conditions that differ significantly from those in widely held ownership systems typical of developed markets. High-profile accounting scandals, including those involving Satyam Computers, IL&FS, DHFL, and the PNB–Nirav Modi scam, have revealed recurring gaps in internal controls, auditor oversight, and board independence, underscoring the need to investigate viii earnings management behaviour within India’s institutional context. The adoption of Ind-AS, which converged with IFRS, represents a significant regulatory development aimed at enhancing the credibility of financial reporting. However, emerging literature suggests that while stricter recognition and measurement rules may curb some forms of accrual manipulation, they may simultaneously incentivise a shift toward more opaque and harder-to-detect forms of earnings management, such as manipulation through real activities. In line with this, the study applies a multi-period empirical methodology to investigate shifts in earnings management behaviour across the pre Ind-AS, post-Ind-AS, and COVID-19 periods. The study is designed to address three fundamental objectives. Initially, the research evaluates how the adoption of Ind-AS influences accrual-based earnings management among Indian companies. The study incorporates Beneish M-score parameters and discretionary accruals to examine the differences between pre- and post-Ind-AS periods. Results indicate that while key indices linked to performance pressure, such as the Gross Margin Index and Sales Growth Index, were strong predictors of accrual manipulation in the pre-Ind-AS era, their influence weakened significantly post adoption. This suggests that enhanced revenue recognition standards and improved disclosure requirements under Ind-AS have reduced opportunities for traditional forms of manipulation. Nevertheless, the continued significance of Total Accruals to Total Assets confirms that accrual-based manipulation has not been eliminated, highlighting the need for more targeted enforcement. The research also seeks to determine whether governance mechanisms are effective in limiting accrual-based and real earnings management under differing economic environments, particularly during the pandemic. Empirical evidence suggests that, under normal economic conditions, board independence, board size, and Big Four auditor engagement serve as effective monitoring mechanisms to curb earnings management. However, these mechanisms lose strength under crisis conditions. During the pandemic, logistic constraints, virtual board meetings, and audit disruptions appear to have diminished oversight quality. Consistent with institutional theory, governance mechanisms operated primarily symbolically rather than substantively, ix thereby weakening their ability to constrain managerial opportunism. Firm-specific attributes, such as size, leverage, and profitability, also exhibit different effects during crisis versus non-crisis periods. Distressed firms exhibit more conservative reporting behavior during the pandemic due to heightened scrutiny and concerns about survival. The third objective investigates whether accrual-based and real earnings management function as substitutes or complements in Indian firms. While firms in stable periods appeared to use these techniques selectively in response to contextual incentives, the pandemic introduced a shift in strategy. As real activity manipulation became costlier and operationally difficult during lockdowns, many firms relied more heavily on accrual adjustments. During the pandemic period, a statistically significant positive relationship between unexpected real and accrual-based earnings management suggests that firms employ these strategies in a complementary manner in response to increased economic pressure. The findings also show that promoter ownership moderates this relationship, with higher promoter dominance curbing manipulation under distress, which may stem from long-term reputational concerns or the ability to absorb temporary losses. Overall, the findings enrich the theoretical discourse on earnings management by demonstrating that managerial reporting choices are shaped by an interplay of regulatory environments, crisis conditions, cost structures, and governance quality. The study contributes to agency theory by highlighting how monitoring failures create opportunities for earnings manipulation; to stewardship theory by revealing contexts in which unified leadership may reduce earnings management; and to institutional theory by showing how governance mechanisms may lose effectiveness during systemic disruptions. It also extends the cost-based trade-off framework by explaining why firms switch between earnings management techniques in response to resource constraints and external monitoring. The study offers important policy implications for regulators, auditors, boards, and investors. Strengthening enforcement mechanisms, enhancing audit independence, adopting data analytics-driven supervision, and promoting genuinely independent x board structures could collectively improve earnings quality. Furthermore, crisis responsive governance frameworks and revised auditing protocols are crucial in preventing opportunistic reporting in volatile environments. By integrating insights from an emerging economy undergoing significant regulatory transformation, this study advances the global understanding of earnings management behaviour and strengthens the literature on corporate governance, financial reporting, and crisis driven managerial incentives.