The Effect of Earnings Management on the Relationship between Financing Decisions and Stock Liquidity in the Egyptian Stock Exchange: An Applied Study

Abstract

Following the recent accounting scandals caused by the bankruptcy of several large international firms, a crisis of confidence regarding the reliability of accounting information and the effectiveness of control mechanisms has occurred. In fact, managers are able to abuse the trust that is supposed to be between firms and their stakeholders by manipulating accounting results. Thus, earnings management has become one of the most addressed topics in the accounting literature. Earnings management is defined by Schipper (1989) as a purposeful intervention in the external financial reporting process, accompanied by the intent of realizing some private gain. The core goal of firms is stockholder’s value maximization by making the best use of the assets financed by equity capital and debt. But to raise capital, stockholders should be motivated to invest. That only occurs if they anticipate positive future firm performance. Therefore, it is in the firm’s interest to report positive earnings growth to meet analysts’ forecasts in order to get capital (Degeorge et al. 1999). However, it is unlikely that firms can meet these expectations all the time, consequently, firms may manage earnings to satisfy stockholders’ expectations. Healy and Wahlen (1999) categorize incentives beyond earning management into three broad classes: 1) capital market motivations, 2) contracting motivations, and 3) regulatory motivations.