Earnings management by banks operating in emerging markets - The case of BRICS countries 

 

 

Relebohile Tigeli 

 

 

 

A research report submitted to the University of the Witwatersrand, Faculty of Commerce, Law and 

Management in partial fulfilment of the requirements for the degree of Master of Management in 

Finance and Investment 

 

 

 

Supervisor 

Professor Thabang Mokoaleli-Mokoteli 

 

 

 

Date 

22 May 2024 

 



  

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DECLARATION  

 

I, Relebohile Tigeli, solemnly affirm that the Research Report submitted herein embodies my intellectual 

efforts. This work, to the best of my knowledge, is original and has not been published or submitted 

elsewhere. This report is being tendered to partially fulfill the academic requirements for the Degree of 

Master of Management in Finance and Investment at the esteemed Wits Business School (WBS), 

University of the Witwatersrand, Johannesburg. I have ensured that any literature, data, or works 

referenced in this report, which is the intellectual property of others, have been appropriately cited and 

acknowledged in the reference section. Furthermore, I declare that I have received authorization from a 

panel constituted by the research committee of the WBS to undertake this research. This work has not 

been previously submitted for any degree or examination at any other University. 

 

 

Signed: 

 

_______________________________________ 

 

________________day of_____________________20________________in_____________ 

 

  

22 MAY 24 MASERU



  

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DEDICATION 

 

This work is first and foremost dedicated to God, the source of my strength and wisdom. Without His 

guidance, this journey would not have been possible. 

To my beloved family, this achievement is a testament to your unwavering support and love. To my 

parents, Malebakeng and Hlapane Tigeli, who have always believed in my dreams and took care of my 

precious daughter, Keratiole “Kierra” Tigeli, while I embarked on this academic journey. Your sacrifices 

have not gone unnoticed and this achievement is as much yours as it is mine. 

To my sister, Jabs, your belief in me and your daily encouragement have been my pillars of strength. You 

have walked this journey with me, hand in hand, from the sleepless nights preparing for tests and exams 

to the finish line. Your support has been invaluable. 

To all my siblings, Baxx, Lee, Boet Kay, Malo, and Diva, your encouraging words and belief in my dream 

have been a source of motivation. Your faith in me has propelled me forward. 

To my partner, my number one supporter and cheerleader, your belief in me surpasses my own at times. 

Your unwavering support has been a beacon of light in this journey. 

Lastly, to my daughter, Kiky (Kierra), thank you for your understanding and support while mummy was 

away. Your love and encouragement have been my driving force. This achievement is dedicated to you. 

May the experience of pursuing dreams and passions firsthand illuminate your path. May this sacrifice 

plant a seed in you that will propel your wings to fly today and in the future. 

This work is a testament to the power of dreams, the importance of family, and the strength of the human 

spirit. It is a reminder that with God, supportive loved ones, and a steadfast belief in oneself, anything is 

possible. 

 

 

 

 

 

 



  

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ACKNOWLEDGEMENTS 

 

I extend my heartfelt gratitude to Professor Thabang Mokoaleli-Mokoteli, my esteemed supervisor, whose 

unwavering support and guidance were instrumental in shaping every facet of this research endeavor. 

Her expertise in the field, insightful feedback, and commitment to academic excellence have been 

invaluable. Her ability to challenge my thinking, while also providing constructive criticism, has 

significantly enhanced the quality of my work. I am truly grateful for the privilege of working under her 

mentorship and the knowledge and skills I have gained throughout this journey. 

I am deeply indebted to the Central Bank of Lesotho for providing me with the opportunity to pursue my 

master’s degree on a full-time basis. Their generous support, both financially and in granting study leave, 

made it possible for me to fully immerse myself in the academic pursuit of knowledge. This experience 

has been transformative, and I am thankful for the Central Bank’s commitment to fostering continuous 

learning and professional development. 

A special acknowledgment goes to my colleague and companion on this academic journey, Khaitseli 

(Katleho Mphuthing). From navigating challenging modules to the intricate process of research report 

writing, Khaitseli has been a supportive teammate, sharing the highs and lows of this academic expedition. 

The camaraderie and collaborative spirit brought immense joy to the entire research experience. 

I would also like to express my gratitude to the Wits Business School research panel committee and Ms. 

Meisie Moya, the Programme Manager, for their unwavering support and guidance. Their contributions 

have enriched this research project. 

Finally, I extend my deepest thanks to my family and friends for their unwavering encouragement and 

understanding throughout this academic pursuit. Their patience and belief in my aspirations have been a 

source of inspiration. 

This research would not have been possible without the collective support of these individuals and 

organizations. Thank you for being integral parts of this academic milestone. 

 

 

 



  

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ABSTRACT 

 

This study was motivated by the intriguing phenomenon of earnings management within commercial 

banks, particularly in the BRICS nations. The choice of BRICS countries was driven by their significant role 

in the global economy and their unique challenges regarding regulatory practices and economic 

structures. The primary objective of this study is to investigate the extent and strategies of earnings 

manipulation within BRICS commercial banks, shedding light on both its motivation and the factors that 

drive such behaviour. Utilizing the Beneish Manipulation Score (M-score) model, the study identifies 

earnings manipulators from non-manipulators. Through the panel regression, the study elucidates the 

underlying objective of earnings manipulation and the factors influencing such behaviour. The findings 

reveal that some banks manipulate their earnings, however, this phenomena is observed in less than 30% 

of the sampled banks.  Notably, the identified purposes for such manipulation include income smoothing, 

capital management, and signaling strategies. Moreover, the findings also highlight the pivotal role 

Factors such as management compensation, firm size, and profitability act as catalysts for earnings 

management, while high leverage and superior audit quality serve as deterrents. Despite the growing 

body of literature on earnings management, there is a noticeable gap in research focusing on BRICS 

nations. This study addresses this gap and underscores the need for regulatory authorities to re-assess 

management compensation structures, enforce stricter auditing requirements, and monitor banks’ 

profitability metrics. It emphasizes the importance of a robust accounting framework and stringent 

auditing practices for ensuring transparency and accountability in the banking sector of BRICS 

countries. To our knowledge, this is the first study to examine the extent, strategies, and influencing 

factors of earnings management within commercial banks in BRICS nations, offering valuable insights for 

policy formulation. 

 

 

 

 

 



  

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Table of Contents 

DECLARATION ............................................................................................................................................... ii 

DEDICATION ................................................................................................................................................. iii 

ACKNOWLEDGEMENTS ................................................................................................................................ iv 

ABSTRACT ...................................................................................................................................................... v 

LIST OF ABBREVIATIONS AND SYMBOLS .................................................................................................... viii 

LIST OF FIGURES AND TABLES ....................................................................................................................... x 

CHAPTER 1 .................................................................................................................................................... 1 

1.1 Introduction .......................................................................................................................... 1 

1.2 Background of the Study ....................................................................................................... 1 

1.3 Problem Statement ............................................................................................................... 5 

1.4 Research Objectives and Questions ...................................................................................... 7 

1.5 Significance of the Study ....................................................................................................... 8 

1.6 Benefits of the Study ............................................................................................................. 9 

1.7 Structure of the Thesis .......................................................................................................... 9 

Chapter Summary ........................................................................................................................... 10 

CHAPTER 2 LITERATURE REVIEW ........................................................................................................... 11 

2.1 Introduction ........................................................................................................................ 11 

2.2 Theoretical Underpinning ................................................................................................... 11 

2.2.1 Information Asymmetry .................................................................................................. 11 

2.2.2 Agency Theory ................................................................................................................. 13 

2.3 The Role of Accounting ....................................................................................................... 16 

2.3.1 The Role of the Auditor ................................................................................................... 18 

2.4 Earnings Management ........................................................................................................ 19 

2.5 Reasons for Earnings Management .................................................................................... 20 

2.6 Methods Used in Earnings Management ............................................................................ 21 

2.7 Methods to Detect Earnings Management ......................................................................... 23 

2.8 Earnings Management and Corporate Governance ........................................................... 23 

2.9  Factors Influencing Earnings Management ........................................................................ 25 

2.10 Impact and Consequences of Earnings Management in Banks .......................................... 27 

CHAPTER 3 METHODOLOGY .................................................................................................................. 29 

3.1 Introduction ........................................................................................................................ 29 

3.2 Data and Data Sources ........................................................................................................ 29 



  

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3.3 Research Design .................................................................................................................. 29 

3.3.1 Detecting earnings management by banks in emerging markets .................................. 29 

3.3.2 Determining factors influencing earnings management. ............................................... 31 

3.3.3 Variable definition ........................................................................................................... 32 

Chapter Summary ........................................................................................................................... 35 

CHAPTER 4  RESEARCH FINDINGS ........................................................................................................... 36 

4.1 Introduction ........................................................................................................................ 36 

4.2 Univariate analysis .............................................................................................................. 36 

4.3  Detection of earnings manipulation using M-score ........................................................... 41 

4.4 Determining the purpose of earnings manipulation .......................................................... 45 

4.5 Factors influencing earnings manipulation ......................................................................... 48 

Chapter Summary ........................................................................................................................... 50 

CHAPTER 5  DISCUSSION AND CONCLUSION .......................................................................................... 51 

5.1 Introduction ........................................................................................................................ 51 

5.2 Discussion of the Findings ................................................................................................... 51 

5.3 Conclusion ........................................................................................................................... 54 

REFERENCES ................................................................................................................................................ 56 

 

 

 

 

 

 

 

 

 

 

 

 

 

  



  

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LIST OF ABBREVIATIONS AND SYMBOLS 

 

AAA American Accounting Association 

ABEM Accrual-Based Earnings Management  

ADF Augmented Dickey-Fuller 

AQI Asset Quality Index 

AUDITQUALITY Measured by Auditor Independence Rotation 

BOARD Board Size 

BRICS Brazil, Russia, India, China, and South Africa 

COMP Management Compensation 

DEPI Depreciation Index 

DSRI Day Sales in Receivables Index 

EBTP Earnings Before Taxes and Provisions 

EM Earnings Management 

FEM Fixed Effects Model 

FSIZE Firm Size 

GAAP Generally Accepted Accounting Principles 

GMI Gross Margin Index 

GMM Generalized Method of Moments 

H₀ Null Hypothesis 

H₁ Alternative Hypothesis 

I(0) Order of Integration at level 

I(1) Order of Integration at first difference 

IASB International Accounting Standards Board 

IFRS International Financial Reporting Standards 

ITC International Trade Commission 

LEVERAGE Financial Leverage 

LEVI Leverage Index 



  

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LLP Loan Loss Provision 

LM Lagrange Multiplier 

LOAN Total Customer Loans 

M-score Manipulation Score 

NPL Non-performing Loans 

POLS Pooled or Panel Least Squares 

PROFIT Profitability 

R&D Research & Development 

REM Random Effects Model 

REM Real Activities Earnings Management 

SA & G Selling, Administration & General Expenses 

SGAI Sales General and Administrative Expenses Index 

SGI Sales Growth Index 

SIGN One Year Ahead Change in Earnings Before Taxes and Provisions 

T1 Tier 1 Capital 

TATA Total Accrual to Total Assets 

ΔGDP Real Gross Domestic Product Growth Rate 

ε Error Term 

μ Residual or Error Term 

 

  

 

 

 

 

 

 

 

  



  

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LIST OF FIGURES AND TABLES 

 

Figure 1  Year-on-year descriptive stats plot over the sample period 

Figure 2  BRICS descriptive plot of variables per country 

 

Table 1  Yearly variable descriptives               

Table 2  Description of variables by country 

Table 3  Augmented Dickey-Fuller test for each variable 

Table 4  M-score of likely and unlikely manipulators 

Table 5  Persistence in the manipulation by BRICS banks   

Table 6  Test of Income smoothing, Capital Management and Signaling over the sample period 

 for bank likely manipulators and unlikely manipulators 

Table 7  Factors influencing earnings manipulation over the sample period  

 

  



  

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  CHAPTER 1 

1.1 Introduction 

This chapter introduces earnings management and its significance in the banking sector, especially in an 

emerging market context. This chapter is organized as follows: Section 1.2 presents the background. 

Section 1.3 discusses the research problem. Section 1.4 outlines the research objectives. Section 1.5 

presents the gap in the literature. Section 1.6 discusses the benefits of the study. Section 1.7 presents the 

structure of the thesis, and the chapter summary concludes the chapter.  

 

1.2 Background of the Study 

Financial reporting is a fundamental process in the banking sector, providing stakeholders with crucial 

information about a bank’s financial performance and position. Accurate and reliable financial reports are 

vital for making informed decisions, such as whether to invest in the bank or assess its creditworthiness 

and compliance with regulatory requirements. Over the years, the concept of financial reporting has 

evolved significantly, driven by the increasing complexity of financial transactions and the need for greater 

transparency and accountability.  The introduction of accounting and reporting standards such as the 

International Financial Reporting Standards (IFRS) has been a major development in this field. These 

standards were designed to ensure the quality, transparency, consistency, and comparability of financial 

reporting globally (Palea, 2013). The use of IFRS in banks, particularly IFRS 9 Financial Instruments, has 

had a profound impact on the way banks account for financial instruments. This standard deals with the 

classification and measurement of financial assets and liabilities, impairment of financial assets, and 

hedge accounting. It introduces an expected credit loss model for recognizing loss allowance to financial 

assets, which can have a significant impact on banks’ reported financial position. Empirical studies have 

shown that the adoption of IFRS improves the quality of financial statements, enhancing the comparability 

and reliability of financial information across different jurisdictions (Iatridis, 2010). Auditors play a vital 

role in the financial reporting process by independently examining and verifying the accuracy and fairness 

of a bank's financial statements. They conduct audits in accordance with relevant auditing standards, such 

as the International Standards on Auditing (ISA), and provide an objective opinion on whether the financial 

statements present a true and fair view of the bank's financial position and performance (Krishnan, 2009). 

This independent verification enhances the credibility and reliability of financial reports, thus increasing 

investor confidence and contributing to the stability of the financial system. 



  

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Earnings figures contained in the annual reports are a cornerstone of financial information, providing 

valuable information about a company’s financial health and performance to investors and other 

stakeholders (Chen et al., 2010). They serve as a primary source of financial information in capital markets 

and act as a good indicator of a company’s future cash flows and its going concern status. However, the 

integrity of these earnings figures can sometimes be compromised by a practice known as earnings 

management. This involves the use of discretion by managers in financial reporting and transaction 

structuring to alter financial reports. Managers tend to manipulate company earnings for various reasons, 

including misleading stakeholders about the company’s true economic performance or influencing 

contractual outcomes tied to reported accounting figures. Often, managers employ this practice to 

achieve specific earnings targets or objectives (Jones, 1991; Burgstahler et al., 2006). The concept of 

earnings management has been extensively studied in the literature, with seminal works by (Healy & 

Wahlen, 1998) providing a comprehensive overview of the methods and implications of this practice. In 

the banking sector, earnings management can occur through various channels.  Managers may select 

accounting procedures and accruals that maximize the value of their bonus awards when based on 

earnings-based bonus schemes (Healy, 1985). The executives of banks may engage in income-increasing 

opportunities to maximize the compensation packages that are linked to the bank’s performance (Klein, 

2002). Furthermore, banks may engage in earnings management when in need of external financing, they 

may present low credit risk and higher reported income to attract more depositors (Kanagaretnam et al., 

2004).  

There are various techniques used in earnings management, some of which have been the subject of 

extensive empirical research. Techniques such as window dressing and the creation of secret reserves are 

used to adjust a company’s financial statements to present a favorable financial position at the reporting 

date. For example, a company might postpone payments to suppliers so that the bank balance will be high 

at the end of the reporting period. Another example is when a company changes the valuation of 

inventories to increase or decrease profits. In banks, one common technique is the manipulation of loan 

loss reserves and provisions to influence reported profitability and credit risk. Off-balance sheet 

transactions, such as securitizations or special purpose entities, are another method used to manipulate 

financial results by affecting the recognition and disclosure of assets, liabilities, and income. These 

techniques can give stakeholders a misleading impression of the bank’s performance. Furthermore, banks 

may engage in regulatory arbitrage, taking advantage of gaps or inconsistencies in regulations to achieve 

their desired accounting results. For example, banks can issue securities to increase regulatory capital, 

while repurchasing common stock, allowing them to manage their risk. This often causes concerns about 



  

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whether banks are following regulations properly and can make it difficult for regulatory authorities to 

assess the financial risks present in banks. 

The motivation for earnings management in the banking sector is multifaceted. At its core, it often lies in 

the desire for managers to meet or beat earnings benchmarks, such as analyst forecasts or prior-year 

earnings (Dechow et al., 2012). This can be achieved by intentionally manipulating earnings to create a 

more consistent and predictable pattern, which can enhance the perceived financial stability of the bank 

and attract potential investors. Another significant motive for earnings management is to avoid regulatory 

scrutiny and intervention. By presenting a more favorable view of the company’s financial position, 

managers can potentially avoid regulatory action that could disrupt the bank’s operations or negatively 

impact its reputation. Additionally, managers may manipulate financial records for their gain, which can 

result in higher bonuses or other forms of compensation linked to the performance of the bank (Schipper, 

1989). These practices can boost the value of the company by presenting a more favorable view of its 

financial position, potentially attracting investment and increasing the company’s stock price. 

Earnings management is particularly important in the banking industry, especially in emerging market 

economies. Banks play a vital as intermediaries, taking savings from individuals and businesses and 

directing them toward investments and productive activities (Allen et al., 2014). They provide credit to 

entrepreneurs and businesses, allocate capital to different sectors of the economy, and offer essential 

payment and settlement services. As a result, the financial health and reporting practices of banks can 

have a significant impact on overall economic stability (Bushman & Williams, 2012).  

The emerging markets environment is a good laboratory to assess earnings management because of the 

unique and sometimes weak economic, regulatory, and institutional features that characterize emerging 

markets, which may create incentives and opportunities for earnings management practices (W. Li et al., 

2017). These markets often have less mature regulatory frameworks, weaker enforcement mechanisms, 

and information asymmetry, which can enable banks to engage in earnings management more easily (Leuz 

et al., 2003). South Africa’s banking sector, in particular, provides an intriguing case study for examining 

earnings management. The country has a dynamic emerging market economy with a mix of local and 

international banks operating within its borders. However, recent developments such as the global 

financial crisis, increasing regulatory scrutiny, and challenges in the domestic economic environment have 

placed pressure on banks to maintain profitability while adhering to strict reporting standards (Chaity & 

Islam, 2021). For example, an increase in cybercrime over the past few years posed a significant challenge 



  

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to the South African banking industry, which in turn increases the concern around the potential earnings 

management practices that distort the true financial position of banks, is a significant concern. 

Earnings management in banks is not just a matter of academic interest; it can lead to systemic risk and 

jeopardize the stability of the financial system (Ceccobelli & Giosi, 2019). This is because banks play a 

crucial role in the economy, and any instability in the banking sector can have far-reaching effects. For 

instance, earnings management can distort the true financial position of banks, leading to the 

misallocation of resources and potentially causing financial crises. Recognizing the critical nature of this 

issue, various stakeholders, including regulators and investors, have a vested interest in closely monitoring 

the financial reporting practices of banks to ensure transparency and accountability (Chaity & Islam, 

2021). This is particularly important in the context of emerging markets, where regulatory frameworks 

may be less developed and enforcement mechanisms may be weaker. By exploring the prevalence of 

earnings management in the banking sector with a particular focus on emerging markets, this research 

aims to contribute to the existing literature by providing insights into the financial reporting practices of 

banks operating in these markets. Specifically, it aims to provide a comprehensive understanding of 

earnings management practices within the BRICS (Brazil, Russia, India, China, and South Africa) banking 

sector. The BRICS countries represent some of the largest and most influential emerging markets in the 

world and their banking sectors play a crucial role in their respective economies. They encompass about 

26% of the world’s land area and 42% of the world’s population, with a combined GDP of about 25% of 

the global economy (Aaron, 2022). Understanding the prevalence, motivations, and factors driving 

earnings management practices in this sector is essential for ensuring the integrity of financial reporting, 

promoting investor confidence, and maintaining stability in emerging market economies. Earnings 

management practices can vary significantly across different countries and regions due to differences in 

regulatory environments, corporate governance structures, and cultural norms. By focusing on the BRICS 

countries, this research aims to shed light on the unique characteristics and challenges of earnings 

management in these major emerging economies. This research will delve into the specific techniques 

used for earnings management in these countries, the regulatory environment that may enable or 

constrain such practices, and the potential impacts on the financial health and stability of banks in these 

markets. The findings of this research could provide valuable insights for policymakers, regulators, and 

investors, and contribute to the development of more effective strategies for mitigating the risks 

associated with earnings management in the BRICS banking sector. 

 



  

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1.3 Problem Statement 

Accounting information plays an important role in addressing the information problems that arise 

between borrowers and depositors in banks. Banks hold loans, which are typically long-term assets, while 

their deposits are short-term liabilities. This creates a maturity mismatch that can expose banks to the 

risk of runs if the value of their assets falls below the value of their depositors’ claims (Diamond & Dybvig, 

1983). Accounting information is essential for addressing this risk by providing transparent and reliable 

information about the bank’s financial position and performance. Additionally, accounting information is 

essential for the prudential regulation of banks. Regulators use accounting information to set capital 

requirements and assess banks’ compliance with regulatory standards. Accurate and reliable accounting 

information is vital for ensuring the safety and soundness of the banking system.  

 Extant literature confirms that banks engage in earnings management practices, including manipulating 

loan loss provisions. This practice compromises the accuracy and reliability of the bank’s accounting 

information which in turn undermines the ability of depositors and regulators to assess the bank’s 

financial position and performance, potentially increasing the risk of runs and regulatory failures.  

The BRICS nations - Brazil, Russia, India, China, and South Africa - play a significant role in the global 

economy, accounting for a sizable proportion of the world’s population and are projected to remain the 

main drivers of growth in the world economy by 2030. As emerging economies, they exert a considerable 

impact on global trade and economic growth. However, each of these nations faces unique challenges in 

terms of regulatory practices and economic structures, making them compelling subjects for study. 

Earnings management practices in banks can involve a variety of techniques and this study focuses on 

income smoothing, capital management, and signaling. Income smoothing involves manipulating 

reported earnings to create a more consistent pattern by deferring profits in good periods to a period 

when the bank will make losses, potentially hiding the true volatility of the bank’s performance. 

Stakeholders may perceive banks with stable earnings as less risky (Gebhardt & Novotny-Farkas, 2011). 

Regulatory capital requirements serve as a safeguard to ensure that banks have sufficient reserves to 

absorb losses arising from credit risk, such as the risk of default. However, it is important to note that 

some banks may engage in capital management practices, such as manipulating provisions for non-

performing loans, to meet regulatory requirements and present a more favorable financial picture. This 

highlights the importance of vigilant oversight and enforcement of regulatory standards to ensure the 

accuracy and reliability of financial reporting. Signaling refers to the use of earnings management 



  

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practices to convey private information to the market.  Banks may engage in this practice to signal private 

information to reflect their financial strength or prospects to investors. By engaging in these practices, 

banks can influence the perceptions of stakeholders and the consequences may be significant. 

(Ozili, 2021) found that African banks audited by a Big 4 auditor use loan loss provisions to smooth income, 

especially during recessionary periods. This suggests that banks may engage in earnings management 

practices to present a more stable financial performance to stakeholders. (Amidu & Kuipo, 2015) found 

that almost all the 330 banks in the 29 African countries sampled engaged in some management of their 

earnings during the period 2002-2009, with bank activity mix and funding models explaining bank earnings 

quality. These findings highlight the widespread nature of earnings management practices in African 

banks and suggest that factors such as bank activity mix and funding models may play a role in driving 

such behavior. Despite these studies, there seems to be a need to continuously understand the magnitude 

of the earnings management phenomena by banks in different emerging market environments 

characterized by weak institutions, low economic growth, and weak legal systems.  

Understanding earnings management by banks in emerging markets is imperative as banks serve as key 

intermediaries by mobilizing savings from individuals and businesses and channeling them toward 

investment and productive activities (Allen et al., 2014). They facilitate credit provision to entrepreneurs 

and businesses, allocate capital to different sectors of the economy, and provide essential payment and 

settlement services (Allen & Santomero, 2001). This fosters innovation, entrepreneurship, infrastructure, 

and economic development. Consequently, the financial well-being and reporting practices of banks have 

far-reaching implications for overall economic stability (Bushman & Williams, 2012). Therefore, there is a 

pressing need to understand the extent of earnings management in these emerging markets and its 

drivers. This study aims to address this gap, providing valuable insights that can inform policy formulation 

and regulatory practices, ensuring that earnings management does not become economically destructive. 

By doing so, this study will contribute to enhancing the safety and soundness of the banking system in 

these critical economies. This makes the study of earnings management in BRICS a critical and urgent 

matter.  

Banks may engage in earnings management practices to signal stability, attract investors, influence stock 

prices, or comply with regulatory requirements (Kanagaretnam et al., 2004). However, manipulating 

earnings can distort the perception of a bank’s financial health and solvency, potentially misleading 

stakeholders and causing systemic risks (Bushman & Williams, 2012). Moreover, it can misallocate capital 

and resources, as investors rely on financial statements and information for decision-making (Leuz et al., 



  

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2003). Earnings management practices can have far-reaching consequences for financial stability, investor 

confidence, and the efficient allocation of resources (Bushman & Williams, 2012). When banks engage in 

earnings management, it can have a negative impact on their efficiency and increase systemic risk. (Chaity 

& Islam, 2021) found that an increase in the practice of earnings management leads to a significant 

reduction in banks’ efficiency. This is because earnings management can distort the true economic 

performance of the bank, making it more difficult for managers to make informed decisions and allocate 

resources efficiently. Earnings management can also increase systemic risk by obscuring the true level of 

risk present in the banking system. If banks engage in practices such as manipulating loan loss reserves or 

using off-balance sheet transactions to hide risks, this can make it more difficult for regulators to 

accurately assess the level of systemic risk and respond appropriately to mitigate it. Policy-makers and 

investors need, to name a few, to understand the extent of earnings management in emerging markets 

and its drivers so that appropriate policies can be adopted to ensure that this practice does not become 

economically destructive. 

 

1.4 Research Objectives and Questions 

The objectives of this study are outlined as follows: 

 To assess the extent to which banks in emerging markets engage in earnings management 

practices. 

 To investigate the earnings management strategies used by banks in emerging markets. 

 To establish the factors (regulatory, institutional, economic) that drive the earnings management 

by banks in emerging markets. 

The related research questions are stated as follows: 

 To what extent do banks in emerging markets engage in earnings management practices? 

 What are the strategies used by banks in emerging markets to manage earnings? 

 What are the regulatory, institutional, and economic factors that influence earnings management 

in emerging markets? 

 

 

 



  

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1.5 Significance of the Study 

Earnings management in banks has been a topic of interest for researchers, with numerous studies 

conducted in both developed and emerging markets. In developed countries, studies have found that 

earnings management through discretionary loan loss provisions can negatively affect the efficiency of 

banks. For example, (Proença et al., 2023) found that discretionary loan loss provisions negatively affected 

the efficiency of Eurozone banks. However, when non-discretionary provisions were included, the impact 

of loan provisions on allocative efficiency was positive. This highlights the importance of properly defining 

earnings management when analyzing its effect on banking efficiency. 

In emerging markets, research on earnings management in banks is less extensive. (Lassoued et al., 2017) 

investigated the relationship between ownership structure and earnings management in the banking 

industry of emerging markets. The findings are that banks with more concentrated ownership use 

discretionary loan loss provisions to manage earnings. (Y. Li et al., 2018)  conducted a study to examine 

the effect of real earnings management on bank lending decisions in China. Their findings indicate that 

firms engaging in higher levels of real earnings management were able to secure more loans at lower 

costs, suggesting that banks may not be effective in detecting such practices. Additionally, (Ujah et al., 

2017) investigated the relationship between bank structure, earnings management, and bank 

performance in international markets, with a focus on non-foreign banks in emerging countries. The study 

found that bank market structure and earnings management negatively affect bank performance, 

especially in banks with higher levels of concentration and earnings management.   Despite these studies, 

there remains a gap in the literature on the prevalence and strategies used by banks in emerging markets 

to manage earnings. The gap further extends to the factors (regulatory, institutional, and economic) that 

drive earnings management by banks in emerging markets. This study aims to fill this gap by conducting 

a comprehensive analysis of earnings management practices in emerging markets looking at the BRICS 

countries' banks, by examining their prevalence, motives, and factors that drive earnings management by 

banks in emerging markets.  

Despite the importance of accurate and reliable accounting information for ensuring the safety and 

soundness of the banking system, research into earnings management practices in emerging markets, 

especially in BRICS, is limited. As far as we know, this is the first study to assess the prevalence of earnings 

management practices in the BRICS countries. This gap in the literature limits our understanding of 

earnings management practices in BRICS banks and their potential consequences for the banking system. 

Manipulating earnings can distort the perception of a bank’s financial health and solvency, potentially 



  

9 
 

misleading stakeholders and causing systemic risks (Bushman & Williams, 2012). Moreover, it can 

misallocate capital and resources, as investors rely on financial statements for decision-making (Leuz et 

al., 2003). Therefore, understanding the nature, extent, and consequences of earnings management is 

crucial for ensuring transparency, accountability, and stability in the banking sector. 

 

1.6 Benefits of the Study 

The research findings may have significant implications for various stakeholders including, policymakers, 

banks, investors, and academics. For regulators and policymakers, the study provides insights into the 

effectiveness of existing regulations and highlights areas where regulatory reforms may be needed to 

mitigate earnings management practices (Leuz et al., 2003). By understanding how banks engage in 

earnings management and the impact of these practices on financial reporting and stability, policymakers 

can develop effective regulatory frameworks to promote transparency and reduce systemic risks.  

Banks can gain insights into the consequences of earnings management practices and the importance of 

transparent financial reporting in building trust and credibility (Kanagaretnam et al., 2004). Banks can 

develop effective internal controls and risk management strategies to ensure the accuracy and reliability 

of their financial reporting.  For investors, the study can reveal the risks associated with investing in banks 

and provide insights into how banks engage in earnings management practices so that they can make 

informed decisions (Bushman & Williams, 2012).  

Overall, this research contributes to the academic literature on earnings management in emerging 

markets, specifically in the BRICS countries' banking sector. It addresses a knowledge gap and provides 

valuable insights into the motivations, techniques, and consequences of earnings management practices. 

 

1.7 Structure of the Thesis 

The final thesis will be structured as follows: Chapter two, delves into a comprehensive review of the 

existing literature on earnings management, highlighting key findings and gaps in the current 

understanding. Chapter three outlines the methodology employed in our research, including a description 

of the data sources, sample selection criteria, and analytical techniques used. This allows for an in-depth 

exploration of our research. Chapter 4 presents the research results and Chapter 5 discusses the findings 

in relation to the existing literature and concludes the research. 



  

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Chapter Summary 

Chapter 1 of the thesis provides an introduction to the topic of earnings management in banks, with a 

focus on emerging markets, particularly BRICS countries. The chapter discusses the background of the 

study, highlighting the importance of financial reporting in banks and the potential consequences of 

earnings management. The problem statement highlights the limited research into the prevalence and 

motivations of earnings management in emerging markets. The research objectives and questions aim to 

assess the extent to which banks in emerging markets manage their earnings, to investigate the earnings 

management strategies used by these banks, and to establish the regulatory, institutional, and economic 

factors that drive earnings management by banks in emerging markets. The significance of the study is 

discussed, highlighting its potential contributions to the development of effective measures to address 

earnings management practices. The benefits of the study are outlined, including its potential implications 

for various stakeholders such as regulators, policymakers, banks, investors, and academics. Finally, the 

structure of the thesis is presented, outlining its organization into five chapters. 

 

 

 

 

 

 

 

 

 

 

 

 



  

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CHAPTER 2 LITERATURE REVIEW 

2.1 Introduction 

This literature review aims to provide a comprehensive analysis of earnings management. The review 

begins by examining the subject's theoretical foundations, focusing on Information asymmetry and 

Agency Theory. Subsequently, it scrutinizes the role of accounting, including an evaluation of the impact 

of accounting standards on the quality of financial statements, an exploration of management discretion 

in accounting, and an assessment of the function of auditors. The review then proceeds to investigate 

earnings management in general and in the banking sector, including an analysis of the motivations for its 

use and the methods employed. Furthermore, it examines techniques for detecting earnings 

management. It also evaluates the interplay between earnings management and corporate governance 

and the factors that influence earnings management. Finally, the review concludes by discussing the 

ramifications and consequences of earnings management. 

 

2.2 Theoretical Underpinning  

2.2.1 Information Asymmetry 

The separation of ownership is common in companies where different individuals hold ownership and 

control. In such a situation, managers look after the firm and have access to all the information related to 

the business, while owners depend upon the managers to get this information. This can result in 

information asymmetry, where the information may not reach the shareholders in the same manner as it 

does the managers (Panda & Leepsa, 2017). Due to this imbalance in information access, managers 

possess greater information asymmetry.  This can lead to a divergence of interests between shareholders 

and managers, where managers may exploit their informational advantage and manipulate financial 

results for personal gain (Steyn & Stainbank, 2013). For example, Enron Corporation is a well-known case 

where managers used their informational advantage to manipulate financial results for personal gain, 

which led to the collapse of the company and significant losses to the shareholders. 

The theory of information asymmetry owes its development to the seminal contributions of three 

distinguished economists: George Akerlof, Michael Spence, and Joseph Stiglitz. Their collective work has 

provided a comprehensive theoretical framework that has greatly enhanced our understanding of this 

phenomenon. (Akerlof, 1970) introduced the concept of information asymmetry. He posited that in many 



  

12 
 

markets, such as those for used cars or insurance, sellers often possess more information about the 

product or service than buyers. This imbalance of information can lead to a market failure, where high-

quality goods are driven out of the market, leaving only the inferior products, or ‘lemons’ behind. (Spence, 

1973) extended the theory of information asymmetry to the labor market. He suggested that potential 

employees often have more information about their own abilities and productivity than employers. To 

overcome this asymmetry, employees may signal their ability to employers by acquiring certain levels of 

education. (Stiglitz & Weiss, 1990), through his extensive work on market screening, brought the concept 

of information asymmetry into mainstream economic discourse. He argued that markets could potentially 

correct for information asymmetry through screening and signaling mechanisms. However, he also 

cautioned that these mechanisms are not always effective and can lead to further market inefficiencies. 

The pioneering work of these proponents has been instrumental in the development and popularization 

of the theory of information asymmetry.  

The theory of Information Asymmetry, while influential, is not without criticism. A primary critique lies in 

the theory’s assumption that the party with less information is incapable of enhancing their knowledge 

or devising strategies to counteract the information asymmetry. This critique challenges the theory’s 

static view of information distribution and highlights the dynamic nature of information acquisition in 

real-world scenarios. For instance, investors and regulators often employ various mechanisms to verify or 

‘screen’ the information provided by banks, thereby mitigating the effects of information asymmetry. 

Furthermore, the theory presupposes that the party with more information will invariably exploit this 

advantage, an assumption that does not always hold true in practice. There are instances where banks, 

despite possessing more information, opt for transparency about their financial health. This strategic 

move is aimed at fostering trust with depositors and investors, thereby enhancing their reputation and 

market standing. This critique underscores the importance of considering the strategic behavior of parties 

involved and the potential for altruistic or reputation-driven actions that deviate from the theory’s 

predictions. 

Information asymmetry between managers and shareholders creates opportunities for earnings 

management, as managers have greater discretion in choosing accounting policies and making estimates 

(Dye, 1988; Trueman & Titman, 1988; Leuz et al., 2003). (Richardson, 2000) provides empirical evidence 

that information asymmetry is positively related to the level of earnings management. The intensity of 

information asymmetry increases during earnings announcements when the quality of earnings is low, 

particularly for companies where earnings are the main source of information for market participants. 



  

13 
 

According to (Bhattacharya et al., 2008), poor-quality earnings can provide informed traders with a 

greater information advantage. These traders can better process available earnings-related information, 

giving them a competitive edge over less-informed traders. To promote fair market participation and 

reduce information asymmetry, companies need to ensure that the quality of their earnings is increased 

or improved.  

Improving the transparency of information disclosure can effectively inhibit earnings management and 

promote companies’ accounting reporting quality to reduce investment risk. (Hunton et al., 2006) found 

that improved transparent reporting requirements could reduce earnings management attempts or 

change the focus of earnings management attempts to less visible methods. (Jo & Kim, 2007) found that 

firms with extensive disclosures are less likely to face information problems, leading to fewer earnings 

management and better post-issue performance. Additionally, (Dai et al., 2013) suggest that information 

forecasts can decrease the information asymmetry between managers and owners, reducing the 

possibility of earnings management. 

Moreover, corporate governance plays a crucial role in reducing information asymmetry between 

managers and shareholders. Measures such as the appointment of independent directors to the board, 

the establishment of an effective audit committee, increased transparency in financial reporting and 

disclosures, and active engagement with shareholders (Cormier et al., 2010; Elbadry et al., 2015) can 

foster better corporate governance. These measures not only reduce the risk of earnings management 

but also decrease information asymmetry. 

Drawing from the theory of Information Asymmetry, we gain a comprehensive understanding of the 

dynamics of information distribution. This perspective becomes particularly relevant when applied to 

emerging markets, where less developed regulatory frameworks may provide banks with more 

opportunities to exploit information asymmetries. The theory emphasizes the role of transparency and 

accountability in financial institutions as pivotal strategies to counteract the adverse effects of 

information asymmetry. This nuanced comprehension can serve as a guide for future research and policy-

making in the field, especially in the context of emerging markets.  

 

2.2.2 Agency Theory 

Agency theory is a concept that explains conflicts that may arise in the relationship between business 

principals and their agents. An example of this relationship is the one between shareholders (principals) 



  

14 
 

and company managers or executives (agents). In this relationship, principals authorize agents to act on 

their behalf by delegating decision-making authority to them (Jensen & Meckling, 1976). However, agency 

theory recognizes that the interests of principals and agents may not always align, leading to what is 

known as the agency problem. This problem, defined as a situation where there are differences in 

priorities, opinions, and interests between the two parties, can result in agents not acting in the best 

interests of the principal. (Jensen & Meckling, 1976) boldly state that this problem exists in every 

organization. (Eisenhardt, 1989) concurs and extends the problem further to include risk sharing that 

occurs when the shareholders and managers have different attitudes and preferences toward risk. 

Principals are risk-neutral and focused on maximizing profits, while agents are risk-averse and focused on 

securing their benefits. 

The agency problem can manifest through earnings management practices. This is where managers, 

driven by the desire to maximize their gain, may manipulate financial reports, thereby prioritizing their 

short-term gain over the long-term interests of the company. Accounting information, particularly 

earnings, is critical in assessing managers’ performance, and bonus schemes can offer incentives for 

managers to choose accounting procedures and accruals that optimize the value of their bonus rewards 

(Healy, 1985). Managers may use discretionary accruals and select income-increasing procedures to 

maximize their bonus earnings or select income-decreasing procedures, a strategy referred to as “taking 

a bath” when earnings are low and targets will not be met (Dechow, 1994). However, firms that include 

non-financial performance measures in their bonus contracts tend to have lower levels of discretionary 

accruals compared to firms that rely solely on financial performance measures (Ibrahim & Lloyd, 2011). 

Several mechanisms have evolved to mitigate agency problems. For instance, compensation plans that 

align the interests of managers with those of the firm by tying a portion of their income to the firm’s 

success (Bodie et al., 2014) through the granting of company stocks (Jensen & Meckling, 1976). 

Additionally, boards of directors may take action to remove underperforming management. Shareholders 

may also exert their influence to replace underperforming boards of directors. Furthermore, other firms 

may acquire underperforming firms, which may then replace the existing management with their own 

(Bodie et al., 2014; Kini et al., 2004), this compels managers to perform efficiently. (Fama, 1980) advocates 

that competing firms in the market also discipline firms by monitoring the whole team's performance. 

(Core et al., 1999) add that the periodic review of executive compensation motivates managers to work 

harder for the better performance of the firm. 



  

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The application of agency theory in this research is particularly relevant as it provides a framework to 

understand the motivations behind earnings management practices. By understanding the agency 

problem and the factors that contribute to it, we can gain insights into why managers might manipulate 

financial reports to prioritize their short-term gain over the long-term interests of the company. 

Despite the robustness of Agency Theory in explaining the dynamics of principal-agent relationships, it is 

not without its gaps and criticisms. The theory’s assumption of self-interest, which suggests that agents 

are primarily motivated by their own benefits, has been challenged. This perspective overlooks the 

possibility that agents may also be driven by other factors such as ethical considerations, professional 

pride, or a genuine interest in the success of the company. This critique suggests a more nuanced 

understanding of agent motivation, one that incorporates both self-interest and other-regarding 

preferences. However, proponents of Agency Theory argue that financial incentives, being quantifiable 

and universally desirable, are more effective and straightforward to implement. Another critique is the 

theory’s assumption of rationality, which suggests that both principals and agents are fully rational and 

will always make decisions that maximize their utility (Jensen & Meckling, 1976). However, decision-

making can be influenced by a range of factors including emotions, cognitive biases, and social influences 

(Kahneman & Tversky, 1979). They developed a theory called the certainty effect, which explains that 

individuals often assign value to outcomes that are certain, compared to those that are merely probable.  

The theory often focuses on financial incentives as the primary mechanism for aligning the interests of 

principals and agents (Jensen & Meckling, 1976). This narrow focus can overlook the potential 

effectiveness of non-financial incentives, such as recognition, job satisfaction, or opportunities for 

learning and development (Herzberg, 1968). The theory also assumes a difference in risk aversion 

between principals and agents (Ross, 1973). However, this may not always hold true, and the risk 

preferences of principals and agents can be more complex and varied (Mitnick, 1975).  

Agency theory offers a lens through which we can examine the complexities of principal-agent 

relationships. This perspective is particularly pertinent in emerging markets where regulatory structures 

may be less mature. The theory underscores the importance of aligning incentives and implementing 

robust governance as strategies to counteract agency problems. It lays a solid foundation for the 

exploration of earnings management practices in emerging markets and highlights the necessity for 

stringent regulatory frameworks and transparency in mitigating agency problems. 

 



  

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2.3 The Role of Accounting   

Accounting is an information system that produces reports about the economic activities of entities for 

stakeholders, providing information about their economic situation and performance over time (Vokshi & 

Krasniqi, 2017). It identifies, measures, and communicates economic information to permit informed 

judgments and decisions by users (American Accounting Association, 1966). For accounting to be 

effective, it requires a well-designed system for managing and recording data, as well as the capability to 

deliver valuable information to its users (Alexander et al., 2007). 

The role of accounting is to provide relevant and reliable financial information to users, including present 

and potential investors, lenders, and other creditors (International Accounting Standards Board, 2010), to 

help them make informed decisions. Accounting involves recording, classifying, and summarizing financial 

transactions to produce financial statements that provide information about a company’s financial 

performance and position. Stakeholders use this information to make decisions about resource allocation 

and risk assessment. Earnings information is important in explaining stock price changes (Ball & Brown, 

1968), demonstrating the value relevance of financial statement information. The quality of financial 

accounting information is crucial for the functioning of capital markets (Xing & Yan, 2019). 

In addition to providing financial information to external users, accounting also ensures compliance with 

laws and regulations, such as tax laws and financial reporting standards. Accounting helps companies 

meet their legal obligations by providing a framework for recording and reporting financial information 

following relevant laws and regulations (Horngren et al., 2012). Additionally, (Garrison et al., 2010) 

highlight the use of accounting information for budgeting and performance evaluation, reinforcing the 

importance of accounting in both external reporting and internal decision-making. 

Furthermore, Accounting standards and practices can influence the reporting of financial information and 

provide opportunities for companies to engage in earnings management. Companies may use different 

accounting methods or estimates to affect reported earnings (Healy & Wahlen, 1998). However, it is 

important for accounting to provide transparent and accurate information to users. A notable example of 

the dire effects of accounting irregularities is the Steinhoff scandal in 2017, leading to a drop in the share 

price of the company. Investor protection plays an important role in influencing international differences 

in corporate earnings management (Leuz et al., 2003). Stronger investor protection can improve the 

quality of financial statements by introducing stricter disclosure requirements and more effective 



  

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enforcement mechanisms, which can reduce the incentives for companies to engage in earnings 

management. 

 

International Financial Reporting Standards (IFRS) are a set of accounting standards developed and 

maintained by the International Accounting Standards Board (IASB). These standards provide guidelines 

for reporting particular types of transactions and events in financial statements. The adoption of IFRS aims 

to improve the quality of financial reporting by providing a common accounting language understood 

globally by investors and other users of financial statements (Okpala, 2012; Palea, 2013). 

The adoption of IFRS enhances the quality of financial reporting (Bodle et al., 2016; Okpala, 2012; Mensah, 

2020) and imposes relatively more disclosure requirements in financial statements. For example, 

companies can provide detailed disclosures regarding specific assumptions and judgments, such as those 

related to revenue recognition, determining the transaction price, and measuring obligations for returns, 

refunds, and other similar obligations. This can improve financial reporting quality and provide more 

information to users. The adoption of IFRS improves investment efficiency, especially for cross-border 

transactions, increases the cross-border flow of capital, and triggers greater interest from foreign 

investors and foreign analysts (De George et al., 2016). 

However, there are also challenges associated with IFRS adoption. The transition to IFRS can be costly for 

many firms (Pawsey, 2017) with costs like staff training, and companies may face difficulties in interpreting 

and applying the standards. Additionally, different countries tend to adopt IFRS through the 

implementation of options that are closely related to their culture (Nobes, 2013), which may hamper 

global comparability in financial reporting. There may also be inconsistencies in enforcement across 

different jurisdictions. Nonetheless, while there are challenges associated with IFRS adoption, it has 

proved to improve the quality of financial reporting by enhancing transparency, comparability, and 

reliability. This can help boost investor confidence and attract more capital to organizations that adopt 

IFRS. 

 

In the context of financial reporting, management is responsible for preparing financial statements that 

are free from material misstatement, whether due to fraud or error and for the effective operation of the 

internal control system and related processes (International Auditing and Assurance Standards Board, 

2006). Management discretion in accounting refers to the flexibility afforded to managers in interpreting 



  

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and applying accounting standards. This discretion is influenced by various factors, including their 

reporting incentives, and those of other participants in the financial reporting process, such as auditors 

and supervisory boards (Ball et al., 2000, 2003; Leuz et al., 2003; Watts & Zimmerman, 1986), and the 

institutional environment of firms (Hail et al., 2010; Kothari, 2000). 

Managers are often required to use their professional judgment when deciding if, and to what extent, 

certain events or transactions should be included in the earnings for the current period. This includes 

impairments, provisions for bad debts, and accruals. Managers have to report earnings that more 

accurately reflect the underlying economics of their firms (Hail et al., 2010). However, this discretion can 

also be misused to misrepresent events and transactions to deceive outsiders about the firm’s 

performance or to influence contractual outcomes in a favorable manner (e.g., (Healy & Wahlen, 1998; 

Watts & Zimmerman, 1986). 

There are conflicting views on management’s discretion in earnings. On one hand, more discretion in 

earnings is associated with opportunistic earnings management and poor earnings quality (Kothari, 2000; 

Ahmed et al., 2013; Ernstberger et al., 2012; J. Francis et al., 2005). On the other hand, managerial 

discretion in earnings is viewed as informative (Arya et al., 2003; Ewert & Wagenhofer, 2013, 2015, 2019; 

Sankar & Subramanyam, 2001), as it conveys managers’ private information and enables them to report 

earnings that more accurately reflect firms’ current and future performance (Hail et al., 2010). 

The consequences of limiting managerial discretion in earnings may likely mitigate opportunistic earnings 

management but may prevent managers from incorporating private information into earnings. A stricter 

enforcement of accounting standards by auditors and other governing bodies can reduce managers’ 

ability to exercise discretion (e.g., (Hitz et al., 2012; Jamal & Tan, 2010; Lu & Sapra, 2009) but it can also 

lower the informativeness of accruals (Windisch, 2021). 

 

2.3.1 The Role of the Auditor  

Audit refers to a skilled examination of company records, accounts, and vouchers to enable the auditor 

to verify the balance sheet of a company. External auditors carry out the independent audit of the financial 

statements and report their findings to the shareholders through an external audit report. An auditor 

must use their professional judgment and skill, despite relying on information from relevant personnel 

(Normanton, 1966). 



  

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The role of the auditor is to assure stakeholders that the financial statements are free from material 

misstatements, which can help reduce earnings management practices (Azad et al., 2023). The auditor 

can achieve this through their ability to detect and report misstatements in the accounting systems or 

financial statements (DeAngelo, 1981). A high-quality external audit can have an influential role in 

reducing earnings management practices by increasing the likelihood of detecting and deterring such 

practices (Frankel et al., 2002). 

The auditor’s report must be accurate and reflect the reality of a company’s financial standing to present 

a true and fair view of the financial statements. For this to happen, the auditor must be competent enough 

to give a sound professional opinion (Sutton, 1997). The auditor is obligated to detect and report fraud to 

management and the nature and effects of the fraud reported to the shareholders of the company. 

Audit partners with industry specialization can reduce real activity earnings management because they 

can better assess their clients’ business risk and will protect their reputation than other auditors (Hsu & 

Liao, 2023). This suggests that auditors with specialized knowledge and expertise in a particular industry 

are better equipped to detect and deter earnings management practices. Another study found that 

auditors charge not only for accrual-based earnings management but also for real earnings management 

because it increases the litigation risks and audit complexity they face by dampening firms’ long-term 

fundamentals (Choi et al., 2022). This highlights the potential costs and risks associated with earnings 

management practices and underscores the importance of the auditor’s role in detecting and deterring 

such practices. 

 

2.4 Earnings Management 

Several authors have defined earnings management as the use of accounting techniques to produce 

financial reports that may be misleading to investors and other stakeholders. For example, (Jones, 1991) 

and (Burgstahler et al., 2006) define earnings management as the use of accounting techniques to 

produce financial statements that present an overly positive view of a company’s business activities and 

financial position. (McNichols, 2000) defines earnings management as the process of taking deliberate 

steps within the constraints of generally accepted accounting principles to bring about a desired level of 

reported earnings. Other authors focus on specific contexts in which earnings management may occur. 

(Chen et al., 2010), for example, define earnings management as the practice of private equity issuing 

firms overstating their earnings in the quarter preceding private equity placement announcements to 



  

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achieve a desired outcome. (Healy, 1985; McNichols & Wilson, 1988; Schipper, 1989) define earnings 

management as a purposeful intervention in the external financial reporting process with the intent of 

obtaining some private gain. 

There are two types of earnings management and these are accrual-based earnings management (ABEM) 

and real activities earnings management (REM) (Brian Lee & Vetter, 2015). REM is achieved through the 

manipulation of operational, investment, and financing activities thereby creating an impression that the 

firm has achieved goals relating to the normal course of business (Elleuch Hamza & Bannouri, 2015; Zang, 

2012; Dutzi & Rausch, 2016; Brian Lee & Vetter, 2015). Lack of or inadequate understanding of the firm’s 

business operations makes the identification of REM difficult (Elleuch Hamza & Bannouri, 2015; 

Ferentinou & Anagnostopoulou, 2016). Sales discounts, selling, administration & general expenses (SA & 

G), and research and development expenses are some of the accounting transactions manipulated in REM 

(Ferentinou & Anagnostopoulou, 2016; Gunny, 2010). The effects of REM may be negligible in the short 

term. REM directly affects cash flow and thus if engaged for long periods it (REM) may result in firm 

bankruptcy.  

ABEM takes place through the manipulation of accounting choices allowed by Generally Accepted 

Accounting Principles (GAAP) to alter the true performance of the firm such as accounting policies and 

estimates (Roychowdhury, 2006; Gunny, 2010). The accounting standards guide, among others, the 

recognition and measurement of accounting transactions. The flexibility with which the accounting 

standards are applied makes ABEM to be easily identifiable by some stakeholders (Elleuch Hamza & 

Bannouri, 2015). This is more so with auditors as they (auditors) are required to have a good 

understanding of the accounting standards. Depreciation and provision for doubtful debts are some of 

the accounting transactions through which ABEM takes place. ABEM does not affect cash flow directly but 

its impact is more pronounced on accruals instead of on cash flow. 

 

2.5 Reasons for Earnings Management  

The extant literature presents various reasons for earnings management. (Healy, 1985) and (Klein, 2002), 

argue that bonus schemes offer incentives for managers to choose accounting procedures and accruals 

that optimize the value of their bonus rewards. In addition, when a company links its CEO’s compensation 

to its performance, the CEO may have a potential incentive to engage in earnings management practices. 

(McNichols & Wilson, 1988) argue that managers may manipulate earnings in response to the firm's 



  

21 
 

optimal financing, production, investment, and marketing strategies. (Jones, 1991), states that firms may 

attempt to decrease earnings through earnings management during import relief investigations by the 

United States International Trade Commission (ITC). External and internal pressures also come into play, 

as (McNichols, 2000; Schipper, 1989; Dechow et al., 2012), contend that managers manage positive 

earnings to meet earnings targets, avoid covenant violations, and influence compensation contracts and 

stock prices.   

As in other industries, multiple factors drive earnings management in the banking sector, reflecting the 

dynamic nature of the industry. (Ceccobelli & Giosi, 2019) highlight that the motivations behind such 

practices often revolve around attracting investment and manipulating stock prices. The pursuit of a stable 

earnings stream creates an impression of reduced riskiness, resulting in advantages such as higher stock 

prices and lower borrowing and capital costs (Gebhardt & Novotny-Farkas, 2011). (Greenawalt & Sinkey, 

1988), who suggest that managers employ income smoothing to decrease the perceived risk associated 

with a bank’s earnings, support this perspective. Conversely, (Kanagaretnam et al., 2003) propose that 

bank managers may engage in income smoothing as a means to attract external financing.  By presenting 

a more stable financial position, banks may be more successful in attracting investors and securing capital 

from external sources. However, it is important to acknowledge that motivations for earnings 

management can vary depending on the specific circumstances of each bank. While some banks may 

primarily focus on attracting investment and manipulating stock prices, others may engage in earnings 

management in response to regulatory pressures and meeting performance targets set by stakeholders. 

Additionally, banks operating in different economic environments or facing specific challenges may have 

unique motivations for employing earnings management techniques.  

 

2.6 Methods Used in Earnings Management  

In the REM front, managers manipulate operating, investing, and financing activities through, 

discretionary expenditures, productions, inventory, sales, sales of long-term assets, stock repurchases, 

and financial instruments (Xu et al., 2007). (Bange & De Bondt, 1998) found that firms adjust research and 

development (R&D) spending to minimize the gap between reported earnings and analysts’ forecasts. 

(Jackson & Wilcox, 2000) found that managers grant sales discounts in the last quarter to avoid reporting 

losses and decreases in earnings. (Herrmann et al., 2003) used income from the sale of long-term assets 



  

22 
 

and marketable securities to minimize the gap between management’s earnings forecasts and reported 

earnings. 

Concerning ABEM, one commonly adopted approach is the use of the aggregate accruals model, where 

total accruals are used as a proxy for discretionary accruals. (Healy, 1985; Jones, 1991; Dechow et al., 

1995) have adopted this approach, with the latter making adjustments to revenue and receivables. 

Another approach is the use of specific accruals models, where a particular accrual is used as a proxy for 

discretionary accruals. For instance, (McNichols & Wilson, 1988) focus on the provision for bad debts as 

a proxy for discretionary accruals. Additionally, researchers have employed various proxies to detect 

earnings management practices, including abnormal accruals (Klein, 2002), the tendency to avoid small 

losses, the magnitude of total accruals, smoothness of earnings relative to cash flows, the correlation 

between accounting accruals and operating cash flows (Burgstahler et al., 2006), and quarterly 

discretionary current accruals (Chen et al., 2010). 

In the banking sector, the two primary methods used to manipulate earnings are income smoothing and 

signaling. (Kanagaretnam et al., 2004) found evidence of income smoothing among banks in Canada by 

loan loss provisions. (Kwak et al., 2009) found a positive relation between discretionary loan loss provision 

and the demand for external financing, realized securities gains, and prior year taxes, whereas a negative 

relation to capital and pre-managed earnings. Additionally, a study found a negative relationship between 

the ratio of loan loss reserves to gross loans and cost efficiency (Ab-Hamid et al., 2018). Loan loss reserves 

serve as the first method banks normally use to cover losses on loans due to defaults and non-payments 

and are usually a better indicator of the bank’s stability on its lending base compared to nonperforming 

loans (Abuzayed et al., 2018). 

Additionally, (Cohen et al., 2014) provided evidence of real earnings management practices through the 

discretionary realizations of security gains or losses. (Elnahass et al., 2014) discuss how bank managers 

accelerate or delay the sale of loans or other securities to affect the timing of gains and losses on sale to 

change cash flows. Further research that supports REM through realized securities gains or losses includes 

(A. Beatty & Harris, 1999; A. L. Beatty et al., 2002; Cornett et al., 2009; Leventis & Dimitropoulos, 2012; 

Abdelsalam et al., 2016).  

 

 

 



  

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2.7 Methods to Detect Earnings Management 

In terms of detecting earnings management, (Dechow et al., 1995) evaluated alternative accrual-based 

models for detecting earnings management by comparing the specification and power of commonly used 

test statistics across the measures of discretionary accruals generated by the models. They found that all 

of the models appear well specified and that a modified version of the model developed by (Jones, 1991) 

exhibits the most power in detecting earnings management. (Kaur et al., 2014) also use the Modified 

Jones model and Beneish M-Score to detect earnings management, with the latter using five financial 

ratios. The results revealed an M-score of greater than -2.22 signaling the use of earnings management. 

Additionally, (Roychowdhury, 2006) uses abnormal production costs, abnormal discretionary expenses, 

and abnormal levels of cash flow from operations to detect earnings management. 

In the banking sector, the commonly used techniques to detect earnings management practices are loan 

loss provisions (Ceccobelli & Giosi, 2019). Other researchers that use loan loss provisions include (Garšva 

& Rudzioniene, 2012; Curcio & Hasan, 2015). A study conducted by (A. L. Beatty et al., 2002), uses the 

classification and measurement of fair value securities to identify earnings management practices in 

financial institutions. The timing of securities sales can have an impact on the profits and losses associated 

with these assets and can play a significant role in earnings management. (Alves Dantas et al., 2013) take 

it a step further by developing and validating a two-stage model for the identification of discretionary 

management actions using gains obtained from securities. The study found evidence of income smoothing 

using securities and the classification of available-for-sale securities among the actions taken by 

management. 

 

2.8 Earnings Management and Corporate Governance  

Corporate governance refers to the system of rules, practices, and processes that control and direct a 

company. Corporate governance mechanisms significantly influence earnings management practices and 

disclosure. For instance, (Biswas et al., 2022; Mensah & Boachie, 2023) found that board gender diversity 

significantly moderates the relationship between corporate governance mechanisms and earnings 

management practices, contributing to improved board quality by fostering creativity, critical thinking, 

reducing bias, and enhancing problem-solving capabilities. Having women directors can intensify the 

monitoring process and reduce managers’ opportunistic behavior. (Huber & DiGabriele, 2021) provide 

evidence that corporate governance also positively influences disclosure. Similarly, (Xie et al., 2003; Klein, 



  

24 
 

2002) showed that corporate governance practices affect earnings quality. (Klein, 2002) found a negative 

relation between audit committee independence and abnormal accruals, as well as a negative relation 

between board independence and abnormal accruals. These results suggest that boards structured to be 

more independent of the CEO are more effective in monitoring the corporate financial accounting 

process. 

The effectiveness of an audit committee’s oversight connects to specific accounting and auditing 

expertise. (Dhaliwal et al., 2010; Sharma et al., 2009) stipulate that former auditors are suitable members 

to strengthen the audit committee’s effectiveness. (Ozili & Outa, 2018) found that former auditors on the 

audit committee are associated with lower earnings management, suggesting that audit committee 

members with auditing expertise and background contribute to the effective monitoring of earnings 

management practices. (Xie et al., 2003) found that board and audit committee meeting frequency and 

members with corporate or financial backgrounds are associated with firms that have lower discretionary 

current accruals. (de Haan & Vlahu, 2016) state that the expertise of directors is particularly crucial in the 

financial industry, leading to an increased demand for audit committee directors with significant 

knowledge and experience in financial reporting. Such expertise will enhance the audit committee’s 

effectiveness and lead to better oversight of management’s behavior. 

(Ittonen et al., 2020) examine the association between earnings management and former auditors on the 

audit committee in US banks. The results indicate that US banks with former auditors on their audit 

committee exhibit lower levels of income-increasing as well as absolute discretionary loan loss provision. 

However, there is some debate on whether appointing affiliated former audit partners to executive 

positions is beneficial or detrimental to financial reporting quality. Studies by (Menon & Williams, 2004) 

argue that such appointments report higher levels of abnormal accruals, indicating an increased risk of 

manipulating financial statements. (Dowdell & Krishnan, 2004; C. Lennox, 2005; C. S. Lennox & Park, 2007; 

Menon & Williams, 2004) concur that the recruitment of afflicted auditors deteriorates financial reporting 

quality and compromises the auditor’s independence. On the contrary, (Dart & Chandler, 2013) report 

that investors do not view hiring a former auditor by an audit client as a threat to the auditor’s 

independence. 

 

 

 



  

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2.9  Factors Influencing Earnings Management  

Several factors can influence earnings management, including debt levels, the size of the firm, industry 

type, and industry tenure.  

 

2.9.1 Debt levels and earnings management 

According to positive accounting theory, companies with higher debt are more likely to violate debt 

covenants and may engage in earnings management activities (Press & Weintrop, 1990; Watts & 

Zimmerman, 1986). For example, (Franz et al., 2014) found that at higher debt levels, a higher financial 

distress cost leads to more earnings management due to pressures to meet debt covenants. Additionally, 

(DeFond & Jiambalvo, 1994) detected income-increasing discretionary accruals in financially distressed 

firms to avoid debt violations, while (Azad et al., 2023) found that managers of distressed firms manipulate 

earnings downward during debt renegotiation to obtain better terms in contract renegotiations. 

According to (Wang & Lin, 2013), the increased profitability of the group reduces the member firms' 

susceptibility to earnings management because of its debt levels. Thus, firms belonging to a profitable 

group are less likely to experience default and the terms in their debt contracts are favorable. 

 

2.9.2 Firm size and earnings management 

The relationship between firm size and earnings management has been widely studied in the literature. 

(Y. Kim et al., 2003) found that small-sized firms tend to engage in more earnings management to avoid 

reporting losses, compared to large- or medium-sized firms. Conversely, large- and medium-sized firms 

are more likely to exhibit aggressive earnings management to avoid reporting decreases in earnings, 

compared to small-sized firms. Other studies have found mixed results. For instance, (Setyoputri & 

Mardijuwono, 2020) found that the size of a company does not affect earnings management, while 

(Burgstahler & Dichev, 1997) found that both large and small firms engage in earnings management. 

According to (Becker et al., 1998; J. R. Francis & Krishnan, 1999), large firms audited by one of the Big 5 

accounting firms report lower levels of discretionary accruals, despite having high overall levels of 

accruals. In contrast, (Jahmani & Niranjan, 2015) found that firm size has a positive impact on earnings 

management. These findings suggest that the role of firm size in earnings management is complex and 

may vary depending on the context. 



  

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2.9.3 Industry type and earnings management 

A firm’s industry can significantly affect its earnings management practices due to unique characteristics 

such as business activities, accounting practices, and regulations (Chevalier, 1995). Firms within the same 

industry often share similar characteristics, which can further influence their earnings management 

practices (Chevalier, 1995). Earnings management activities vary across industries (Wasiuzzaman, 2018) 

influenced by factors such as accounting standards, industry-specific taxes, and capital market structures 

(Burgstahler et al., 2006; McNichols, 2000). Studies have found evidence of higher occurrences of earnings 

management attempts in some industries compared to others (Nelson et al., 2002; Rath & Sun, 2008), 

and industry variables such as capital intensity, volatility, and profitability can help explain these variations 

(Wasiuzzaman, 2018). The study found that volatility only explains smoothing measures, while 

profitability only explains discretionary measures. Additionally, a study analyzing 12 firms from different 

industries found that the type of earnings management activity varied across industries, with firms in the 

services sector engaging in income-decreasing earnings management and firms in the non-services sector 

engaging in income-increasing earnings management (Goel, 2012). 

 

2.9.4 Industry tenure and earnings management 

Several factors affect industry tenure and earnings management. On the one hand, longer employee 

tenure can be positively associated with earnings management through real activities manipulation (REM) 

when managers persuade employees that their actions benefit the firm's long-term survival (Cho et al., 

2021). On the other hand, long-tenured employees may be better at detecting real activities manipulation 

due to their greater knowledge and experience of daily operations, resulting in a negative relationship 

between employee tenure and real earnings management (Cho et al., 2021). 

In terms of audit firm tenure, previous research has shown that longer audit firm tenure is associated with 

lower levels of earnings management and, as a result, higher earnings quality (e.g. (Gul et al., 2009; 

Johnson et al., 2002; El Guindy & Basuony, 2018) discovered a negative relationship between audit firm 

tenure and earnings management for UK firms that had not changed their accounting standards. Longer 

audit firm tenure improves audit quality without compromising auditor independence. (Hsu & Liao, 2023) 

found that industry specialization and audit firm tenure have a negative effect on earnings management. 

 



  

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2.10 Impact and Consequences of Earnings Management in Banks  

The consequences of earnings management can be far-reaching and can have negative impacts on the 

accuracy and transparency of a company’s financial reporting (Klein, 2002). It can also reduce the quality 

and reliability of financial reporting, impair the usefulness of accounting information for decision-making, 

increase the cost of capital, and damage the credibility and reputation of the firm and its managers 

(Schipper, 1989). Additionally, it can affect the efficiency of resource allocation and the credibility of 

accounting standards (McNichols, 2000). Sophisticated investors may not be able to uncover the true 

value of firms when they engage in earnings management (Chen et al., 2010). This can result in investors 

not asking for a fair discount when purchasing the shares of private issuing firms. Earnings management 

can also have negative consequences such as loss of reputation or loss of employment for managers who 

engage in it (Dechow et al., 2012).  

Several companies have faced scandals due to earnings management practices. For instance, Enron hid 

its financial condition using complex financial instruments, which ultimately led to its bankruptcy. 

Similarly, Worldcom capitalized expenses that should have been expensed, resulting in the stock price 

plummeting and bankruptcy. Tyco International’s executives used accounting tricks to inflate earnings 

and misused company funds, causing the stock price to fall and the CEO convicted of fraud. Xerox 

International manipulated revenue from long-term leases and deferred expense recognition, leading to a 

falling stock price and a large fine. Wells Fargo employees created unauthorized accounts to meet sales 

targets, which resulted in a large fine and damage to the bank’s reputation. These examples demonstrate 

the consequences of unethical earnings management practices. 

The consequences of earnings management in the banking sector can be significant. Engaging in such 

practices can undermine investor confidence, compromise the effectiveness of regulatory oversight, and 

potentially lead to adverse market reactions and systemic risks. For example, the 2008-2009 financial 

crisis, which had a profound impact on both the economy and the financial sector, has been linked to 

earnings management practices (Filip & Raffournier, 2014). Given the critical role that banks play in the 

economy, it is essential for regulators and other stakeholders to closely monitor earnings management 

practices in this sector. Recent studies have provided evidence of the negative impact of earnings 

management on banks’ performance. (Martens et al., 2021) found that efficiency is negatively associated 

with earnings management, indicating that engaging in such practices can lead to a decline in efficiency 

and stifle a firm’s growth and competitiveness. (Proença et al., 2023) reported that earnings management 

negatively affects banks’ profitability, prevents efficient resource allocation, and causes costs to exceed 



  

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minimum levels. Similarly,(Mangala & Singla, 2021) found that earnings management reduces the return 

on equity, return on assets, and net interest margin. These findings suggest that earnings management 

has major negative implications for banks’ financial performance, both in the short term and in the long 

term. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



  

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CHAPTER 3 METHODOLOGY 

3.1 Introduction 

This chapter presents the research methodology used in this study to investigate the existence and 

underlying motives as well as drivers of earnings management practices in BRICS banks. The Chapter is 

organized as follows: Section 3.2 presents data and data sources. Section 3.3 presents the research design 

and the chapter summary concludes. 

 

3.2 Data and Data Sources 

The data used in this study is obtained from the income statements and balance sheets of sample 

companies. The focus is on earnings and loan loss provisions from the income statement and the 

corresponding allowance for loan and lease losses from the balance sheet, which represent the total 

amount of loan loss reserves that banks set aside to cover potential losses on their loan portfolios.  

Commercial banks listed on the stock exchanges of the BRICS countries as the selected emerging markets 

will be included in the sample and they must have annual time-series data for loan loss provisions and at 

least four consecutive years of data for key variables such as earnings, total assets, and total equity. Banks 

that do not meet these requirements are excluded from the sample to ensure that the analysis is based 

on reliable and consistent financial reporting. The sample period is 10 years (2013 to 2022). Data is 

collected from sources such as Data Stream, Bloomberg, BRICS countries' Stock Exchanges, and sample 

banks’ websites.  

 

3.3 Research Design 

3.3.1 Detecting earnings management by banks in emerging markets  

The first part of this analysis investigates the existence of earnings management practices by banks 

operating in emerging markets, represented by BRICS countries, which include Brazil, Russia, India, China, 

and South Africa. Beneish M-score model is used to identify banks that are likely manipulating their 

earnings.  The model uses eight variables related to financial ratios, and it distinguishes earnings 

manipulators from non-earnings manipulators. The indicators used in the M-score are the Day Sales in 

Receivables Index (DSRI), Gross Margin Index (GMI), Asset Quality Index (AQI), Sales Growth Index (SGI), 



  

30 
 

Depreciation Index (DEPI), Sales General and Administrative Expenses Index (SGAI), Leverage Index (LEVI) 

and Total Accrual to Total Assets (TATA). The M-score greater than the benchmark of (-2.22) is flagged as 

an earnings manipulator, while that less than the benchmark is not a likely manipulator (Beneish, 1999).  

The M-score model is measured by the following equation: 

𝑀 − 𝑠𝑐𝑜𝑟𝑒 =  −4.84 + 0.920(𝐷𝑆𝑅𝐼) + 0.528(𝐺𝑀𝐼) + 0.404(𝐴𝑄𝐼) + 0.892(𝑆𝐺𝐼) + 0.115(𝐷𝐸𝑃𝐼)

− 0.172(𝑆𝐺𝐴𝐼) + 4.679(𝑇𝐴𝑇𝐴) − 0.327(𝐿𝐸𝑉𝐼) 

 

With banks identified and flagged as earnings manipulators, we will use financial data for these banks to 

test the purposes of earnings management. To ascertain the purpose and practice of earnings 

management, we employ a specific accrual-based model and conduct a regression analysis with loan loss 

provision serving as the dependent variable. The independent variables include non-discretionary 

variables such as non-performing loans and total customer loans, as well as discretionary variables such 

as earnings before taxes and loan loss provisions, regulatory capital, and a sign variable.  

Specifically, we test to determine whether banks manage earnings for income smoothing, capital 

management, or signaling. Income smoothing refers to the practice of using accounting techniques to 

reduce fluctuations in reported earnings. Capital management refers to the manipulation of financial 

statements to meet regulatory capital requirements. Signaling refers to the use of financial statements to 

convey information to investors or other stakeholders.   

The model determining the purposes of earnings management in banks is presented as follows: 

𝐿𝐿𝑃𝑖,𝐽,𝑡 =  𝛼0 +  𝛼1𝑁𝑃𝐿𝑖,𝐽,𝑡 + 𝛼2𝐿𝑂𝐴𝑁𝑖,𝐽,𝑡 + 𝛼3𝐸𝐵𝑇𝑃𝑖,𝐽,𝑡 + 𝛼4𝑇1𝑖,𝐽,𝑡 +  𝛼5𝑆𝐼𝐺𝑁𝑖,𝐽,(𝑡+1,𝑡) + ∆𝐺𝐷𝑃𝐽 +

 𝜀𝑖,𝐽,𝑡                                                                                                                                                        (1)                                 

Where; 

 i = bank, t = year, J = country 

LLP = loan loss provision ratio to total assets, NPL = non-performing loans to total assets, LOAN = total 

customer loans to total assets, EBTP = current earnings before profit and taxes and provisions to total 

assets, T1 = regulatory capital divided by risk-weighted assets that occurred, SIGN = one-year-ahead change 

in earnings before taxes and loan loss provisions to total assets, ∆GDP = real gross domestic product growth 

rate, a proxy for the state of the economy and ε = the residual or error term. 



  

31 
 

3.3.2 Determining factors influencing earnings management.  

The second segment of this analysis delves into the factors influencing earnings management within BRICS 

banks. To facilitate this, a dynamic panel estimation, specifically the Generalized Method of Moments 

(GMM), is employed. GMM effectively addresses issues of serial correlation, heteroscedasticity, and 

endogeneity inherent in a model (Alimi, 2015). Consequently, it is particularly suited to handle the 

dynamic nature of data related to the factors influencing earnings management and its practices. 

The panel regression and GMM regression analyses are conducted using the student version of Eviews 13. 

In this model, the measure of earnings management derived from the first stage of analysis serves as the 

dependent variable, while the factors influencing earnings management are treated as independent 

variables. Earnings management (EM) represents the discretionary component of loan loss provision (a 

proxy for earnings management). This portion captures a portion of LLP that cannot be explained by the 

model, which is assumed to represent discretionary loan loss provisions. While the independent variables 

are represented by management compensation (COMP), the size of the board of directors (BOARD), firm 

size (FSIZE), profitability (PROFIT), financial leverage (LEVERAGE), and audit quality represented by auditor 

independence rotation (AUDITQUALITY). The coefficients of the independent variables in the regression 

model represent the impact of each independent variable on earnings management, after accounting for 

the effects of all other variables in the model. This approach ensures a comprehensive understanding of 

the dynamics at play in earnings management within BRICS banks. 

 

The model determining the factors influencing earnings management in banks is presented as follows: 

𝐸𝑀𝑖,𝑡 =  𝛽0 +  𝛽1𝐶𝑂𝑀𝑃𝑖,𝑡+𝛽2𝐵𝑂𝐴𝑅𝐷𝑖,𝑡 +  𝛽3𝐹𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝛽4𝑃𝑅𝑂𝐹𝐼𝑇𝑖,𝑡 +  𝛽5𝐿𝐸𝑉𝐸𝑅𝐴𝐺𝐸𝑖,𝑡 +

 𝛽6𝐴𝑈𝐷𝐼𝑇𝑄𝑈𝐴𝐿𝐼𝑇𝑌𝑖,𝑡 +  𝜇𝑖,𝑡                                                                                                                                              (2) 

 

Where;  

𝛽0 = a constant and 𝛽1 𝛽2 𝛽3 𝛽4 𝛽5 𝑎𝑛𝑑 𝛽6 = the coefficients of the independent variables 

LEVERAGE = is measured by debt to total assets, PROFIT = is measured by return on assets, FSIZE = natural 

logarithm of total assets and is used to control for bank size, AUDITQUALITY = is measured by auditor 

independence rotation being the number of years since the last change, and μ = the error term. 



  

32 
 

The estimates of the coefficients for each of the independent variables represent the relationship 

between these variables and earnings management. 

3.3.3 Variable definition 

3.3.3.1 Days Sales in Receivables Index (DSRI): The DSRI is a measure that compares the ratio of 

receivables to sales in year t with that of year (t - 1). If the DSRI is greater than 1, it indicates that the 

percentage of receivables to sales in year t is higher than in year (t - 1). A large increase in the DSRI could 

be due to a change in credit policy to inflate revenue, and thus, a large increase in the DSRI is associated 

with a higher likelihood that revenues/earnings are overstated. 

𝐷𝑆𝑅𝐼 =
?