Impact of Earnings Manipulation on Capital Structure

Performance and Firms Illiquidity: Evidence from South

Asian Countries

Final Year Project (2019-20) Supervisor: DR Adnan Shoaib

Omer Khan (i16-1566)
Faiq Fawad (i161551)
Amar Nadeem (i16-1578)
Abdullah Adrees (i16-1572)
 Introduction
Earning
Manipulation

Motivation
LITERATURE REVIEW
 It is previously established
that there is relationship
between earning
management and
leverage. However,
previous studies missed out
moderation of capital
earning on capital
structure and illiquidity. The
present study addresses this
gap in empirical manner
 RESEARCH QUESTIONS

How firm manipulate

earnings in Asian
cuntries?

What are
How the capital
theoretical
structure theory
implications in term
shifts due to
of liquidity and
earning
capital structure,
manipulation?
for firm?

What is the impact

What is the impact
of earning
of earning
manipulation on
manipulation on
capital structure
liquidity?
performance?
 Objectives
To identify theoretical
To identify Impact of shift in capital structure
earning manipulation on settings due to
the capital structure manipulation of earnings
performance and liquidity.

To identify whether the To adopt the efficient

firm liquidity effect the methodology to address
manipulation intent of the changes in capital
Capital structure structure performance in
performance. presence and absence
of earning manipulation.
 INTELLECTUAL CONCEPT
• Capital structure Theories:

• Modigliani – Miller Model

• Trade-off Theory
• Pecking order theory
• Signaling Theory
• Agency cost theory

• Illiquidity Theory:

• Liquidity Preference Theory – John Maynard Keynes

 Firm
Performance
𝑁𝑒𝑡 𝐼𝑛𝑐𝑜𝑚𝑒
(𝑅𝑂𝐴 = )
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠

Earning
Management

Leverage Liquidity Capital Intensity Size Growth

𝐼𝐿𝐿𝐼𝑄
Leverage =
𝐷𝑒𝑏𝑡
1 𝑇 𝛾𝑡 CI=1/Asset 𝑆𝑖𝑧𝑒 = ln 𝑆𝑖𝑧𝑒𝑡 𝑔 = 𝑏𝑟
𝐸𝑞𝑢𝑖𝑡𝑦 = ෍ turnover ratio
𝑁 𝑡=1 $𝑉
 Financial Model

• 𝑅𝑂𝐴 = 𝛼 + 𝛽1 𝐿𝐸𝑉 + 𝛽2 𝐶𝐼 + 𝛽3 𝑆𝑖𝑧𝑒 + 𝛽4 𝐺 + 𝛽5 𝐿𝑄

1 (∆𝑅𝑒𝑣−∆𝑅𝑒𝑐𝑡 𝑃𝑃𝐸
• 𝑇𝐴𝐶 = 𝛼 + 𝛽1 + 𝛽2 + 𝛽3 + 𝛽4 𝑅𝑂𝐴 + 𝜀 (Kothari, Leone, &
𝐴 𝐴 𝐴
Wasley, 2005)
• 𝑅𝑂𝐴 = 𝛼 + 𝛽1 𝐿𝐸𝑉 + 𝛽2 𝐶𝐼 + 𝛽3 𝑆𝑖𝑧𝑒 + 𝛽4 𝐺 + 𝛽5 𝐿𝑄 + 𝛽6 𝐿𝐸𝑉 𝐷𝐴 +
𝛽7 𝐶𝐼 𝐷𝐴 + 𝛽8 𝑆𝑖𝑧𝑒 𝐷𝐴 + 𝛽9 𝐺 𝐷𝐴 + 𝛽10 𝐿𝑄 𝐷𝐴 + 𝜀
 SIGNIFICANCE AND JUSTIFICATION
• Investors
• Firms manipulate their earnings to show better profitability
• They can attract more investors
• Firms
• Optimum requirement of debt and equity to obtain such capital structure
• Result in maximum value of the company
• Academics
• New pathways
• Illiquidity dynamics