Does earnings quality instigate financial flexibility? New evidence from emerging economy

Purpose: This research aims to examine the empirical relationship between earnings quality and financial flexibility, i.e., how information related to earnings affects firms’ cash levels in the emerging economies.Design/Methodology/Approach: To attain the research objectives, we used panel data for 18 years (2000–2017) obtained from the CSMAR database. Statistical software STATA used for data analysis. Descriptive, multiple correlations, and unbalanced panel data analysis are used.Findings Our empirical results negate the works conducted on the advanced economy showing that information related to earnings (Earnings Quality) is negatively associated with firms’ Financial Flexibility irrespective of firms’ characteristics, i.e., firms with profit or loss and firm’s with R&D or without R&D expenditure. However, the firm’s earnings quality, firm size, cash flows, financial constraints, dividends, and growth are the dominant predictor of financial flexibility. Moreover, the degree of dominance depends on the firm’s specific characteristics.Research Limitations/Implications This research has been conducted on the emerging Chinese market. For consistent and robust results, this research excluded the financial and other firms that possess different operational and regulatory attributes than the manufacturing firms. The study is useful for policymakers and managers to design their cash levels and avoid the hurdle of external finance or to accelerate their flexibility to raise money from an external source.Originality/Value Previous research addressed the issue related to cost and benefit, information asymmetry, ownership concentration, and firm’s propensity to cash holdings. A very little research conducted with earnings quality and cash holdings in the developed market (in Europe and the USA), and thus, for the first time, we address the issue of earnings quality and financial flexibility in the emerging economy.