Financial Statement Analysis &

Forensic Accounting

By: Group 4
Development of Hypothesis
● Hypothesis:

Companies with credit rating near to investment grade (BBB and BB) are more likely to
engage in earnings management

● Arguments:

○ Companies desire to be in the category of investment grade as it gives them a better

reputation with investors which help them to obtain cheaper lines of credit.

○ Therefore, companies close to the investment grade threshold have better incentive to
manipulate and hence are more likely to engage in earnings management.

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 Empirical Equation
EMi,t = ꞵ0+ꞵ1*PCR+ꞵ2*EMt-1+ꞵ3*PInd+ꞵ4*PAge+ꞵ5*PSize+ꞵ6*PLev+ꞵ7*PDiv+ꞵ8*PCG+ꞵ9*PBig 4+ꞵ10*PFam+ꞵ11*Pdual+ꞵ12*PROA+ei,t

# VOI, Control variables and their relevance in the empirical equation:

● EM = Earnings Management
● PCR (Credit Rating) = VOI

● EMt-1 = Historical EM

● PInd (Independent Director): If there are more number of independent directors present in the firm, the possibility of
earnings management manipulation is less to fulfill one’s personal ambitions or financial motives
● P Age (Firm’s Age): Older firms are more likely to engage in earning manipulation as more analysts are looking at the
company and to achieve their forecasted earnings older firms will more likely manipulate earnings

● PSize (Firm’s Size): Larger is the size of the firm, it is more likely that the top leaders of the firm will commit fraud or
manipulate the financial statements in order to showcase higher financial growth of the company
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Control Variables Relevance

● PLev (Leverage): More levered firms tend to do more earnings management as they need to maintain DSCR and
debt covenants set by banks.

● PDiv (Board Diversity): Divers the members of board in the firm (Presence of more females), will discourage
earnings management as female are more ethically sensitive and speak out against unethical practices

● PBig 4 (Audited by Big 4): Firms having BIg 4 are less likely to indulge in earnings management as Big 4 have to
maintain their image in market and do not promote earnings management

● PFam (Family Firms): Family firms tend to manipulate more since they have to maintain their legacy going forward

● PDual (CEO Duality): Firms having CEO duality are tend to engage more in earnings manipulation since there is
more concentration of power in few hands

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Control Variables Relevance
● PCG (Corporate Governance): Firms that do not follow tend to indulge more in earnings management as they
don't follow the ethical code of conduct or rules and regulations followed in the industry.

● PROA (Return of Asset): ROA refers to a financial ratio that indicates how profitable a company is in relation to its
total assets. If ROA is less, companies will usually tend to indulge in earnings management as they wanted to
showcase favourable financial statements.

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Thank You

By: Group 4

M382-21 Patil Akshay Sambhaji

M331-21 Anupam Jindal
M411-21 Srishti
M229-21 Anshuk Polas
M291-21 Shakshi Banka