Equity-hungry firms inflate, debt-laden firms restrain, reveals IIM-I study

CORPORATE PRESSURE| Equity-constrained firms are more likely to manipulate earnings, while debt-constrained firms tend to adopt more conservative reporting practices

- ATUL GAUTAM

A study by Indian Institute of Management Indore has revealed that financial constraints affect earnings management in opposite ways depending on whether firms rely on equity or debt.

Equity-constrained firms, typically younger and R&D-driven, face higher information gaps with investors and are more likely to inflate earnings to secure funding.

In contrast, debt-constrained firms, which are larger and more leveraged, avoid manipulation to prevent covenant breaches and higher borrowing costs.

The research also found that investment opportunities amplify these tendencies, highlighting that financing choices directly shape reporting behaviour.

The study, conducted by Prof Pradip Banerjee of IIM Indore, has shed fresh light on how different types of financial market pressures shape corporate reporting behaviour.

Published in the Australian Journal of Management, the research highlighted that constraints in equity markets and debt markets push firms in fundamentally different directions when it comes to managing earnings.