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Features of the Association between Debt and Earnings Quality for Small and Medium-Sized Entities

Author

Listed:
  • José Sequeira

    (ISCAP, Polytechnic of Porto, 4465-004 Matosinhos, Portugal)

  • Cláudia Pereira

    (CEOS.PP, ISCAP, Polytechnic of Porto, 4465-004 Matosinhos, Portugal)

  • Luís Gomes

    (CEOS.PP, ISCAP, Polytechnic of Porto, 4465-004 Matosinhos, Portugal)

  • Armindo Lima

    (CEOS.PP, ISCAP, Polytechnic of Porto, 4465-004 Matosinhos, Portugal)

Abstract

The main source of financing is bank loans for Portuguese small and medium-sized entities (SMEs), which implies several constraints to obtaining additional funds. Relying on the argument of Positive Accounting Theory (PAT) that accounting choices are not neutral and on Agency Theory that information asymmetry prevails between insiders and outsiders, we analyzed the impacts of debt on earnings quality, focusing on its level, its increases, and its term of payment. We estimated econometric regressions using panel data with fixed effects over 2013–2019, using discretionary accruals as an inverse proxy of earnings quality. We found empirical evidence that the relationship between debt and earnings quality tends to vary in sign, as the quality of financial information deteriorates with debt, but as debt becomes high, firms tend to increase the quality of earnings. Furthermore, we found that short-term debt tends to decrease earnings quality more than long-term debt. This article aimed to contribute to the prior literature by collecting evidence that debt levels tend to be an incentive to increase earnings management and fill the gap by analyzing the influence of different debt features. This evidence is useful because earnings management may compromise both stakeholders’ confidence and the efficient allocation of capital.

Suggested Citation

  • José Sequeira & Cláudia Pereira & Luís Gomes & Armindo Lima, 2024. "Features of the Association between Debt and Earnings Quality for Small and Medium-Sized Entities," Risks, MDPI, vol. 12(2), pages 1-13, February.
    • Handle: RePEc:gam:jrisks:v:12:y:2024:i:2:p:32-:d:1332721
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    References listed on IDEAS

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    1. Dechow, Patricia & Ge, Weili & Schrand, Catherine, 2010. "Understanding earnings quality: A review of the proxies, their determinants and their consequences," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 344-401, December.
    2. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    3. Heung Joo Jeon & Hyun Min Oh, 2020. "Debt Origin and Investment Efficiency from Korea," IJFS, MDPI, vol. 8(3), pages 1-27, August.
    4. Kothari, S.P. & Leone, Andrew J. & Wasley, Charles E., 2005. "Performance matched discretionary accrual measures," Journal of Accounting and Economics, Elsevier, vol. 39(1), pages 163-197, February.
    5. Rifka Aulia Inayah, 2021. "Analysis the Effect of Financial Distress, Leverage and Free Cash Flow on Earnings Management," GATR Journals afr203, Global Academy of Training and Research (GATR) Enterprise.
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