Does good corporate governance constrain cash flow manipulation? Evidence from India

Accounting frauds like Enron in the United States and Satyam in India are likely to have occurred due to the failure of firm-level corporate governance mechanisms in constraining unethical financial reporting practices. In this paper, we examine whether such corporate governance measures and regulatory reforms constrain the manipulation of operating cash flows, an important firm performance indicator. We focus on an emerging market, India where corporate governance and regulations are weak, and business groups and founding owners dominate the corporate landscape. We find that cash flow manipulation is likely to increase with an increase in the promoters’ shareholding. Further, board diligence and better audit fail to curb such manipulation. Our findings suggest that managers seem to move from earnings management towards cash flow manipulation. However, we do find that such manipulation has gone down in the recent years, and diligent boards constrain it, possibly due to the recent steps taken by the Indian Government for improving the corporate governance environment in India.