Real earnings management and the cost of debt capital: international evidence

Abstract

This study examines the association between the extent of real earnings management and the cost of debt capital in an international setting. Using a sample of 14,654 observations across 18 countries from 1987 to 2013, we find that on average, the extent of real earnings management is positively associated with the cost of debt capital. Moreover, we find that debt investors impose more premiums on the cost of debt capital for the firms in countries with more developed debt markets. This study contributes to the literature in the following ways: To begin with, this is the first international study to examine the effect of firms’ real earnings management on the cost of debt capital. Next, this study suggests that the association between the extent of real earnings management and the cost of debt capital varies depending on the institutional environment of the country a firm is based in. Finally, this study implies that financial policy makers need to extend bond market development in order to encourage debt investors to price the negative effects of real earnings management on the firm’s future performance.