Efficiently monitoring the ship of financially distressed companies sinking in Iron law of earnings management: Evidence from Pakistan

Figures & data

Figure 1. Proposed model

Table 1. Variables description

Variable name	Symbol	Definition	Expected relationship
Dependent variable:
Financial distress	FD	FD is a dummy variable coded 1 if it fulfills any of the following three conditions. “if the net income for the current year is negative” or “if the working capital for the current year is negative” or “if both the net income and working capital for current year are negative” Firms not fulfilling the above criteria will be categorized as non-distressed firm, hence coded 0.
Independent variable:
Earnings management	EM	Discretionary Earnings Management for firm i in time t estimated as residual of (Kasznik, 1999) model	Positive (+)
Moderator:
Ownership structure	OwnSt	An index consisting of 14 indicators of ownership. The highest score will therefore be 14 with 0 lowest score. Higher value indicates strong ownership structure whereas lower value indicates weak ownership structure. Definition and scoring criteria of the ownership structure indicators is attached in appendix A.	Negative (–)
Control variables:
Profitability	ROE	Net income divided by shareholders’ equity.	Negative (–)
Firm size	Sze	Natural log of book value of total assets (adopted from).	Positive (+)
Leverage	Lvg	Long term debts divided by total assets (LTD / TA).	Positive (+)
Liquidity	Lqdty	Quick assets divided by Current liabilities (QA / CL). QA = Cash + Bank + Marketable securities	Negative (–)

Table 2. Descriptive statistics and test of difference in means of financially distressed and non-distressed companies

	Descriptive statistics		Test of difference in means
	Mean		Mean difference (t-test)
	FD = 1	FD = 0
EM	−0.170	−0.519	−0.349 ** (0.000)
OwnSt	0.471	0.604	0.132 ** (0.000)
ROE	0.095	0.203	0.108 ** (0.000)
Sze	15.458	15.351	−0.107 (0.154)
Lvg	0.139	0.069	−0.070 ** (0.000)
Lqdty	0.540	1.204	0.663 ** (0.000)

* significant at 5% level of significance

** significant at 1% level of significance

Table 3. Correlation matrix

	EM	OwnSt	ROE	Sze	Lvg	Lqdty
EM	1
OwnSt	−0.115**	1
ROE	−0.038	0.075**	1
Sze	−0.036	0.018	0.108**	1
Lvg	0.047*	−0.080**	−0.049*	−0.038	1
Lqdty	0.020	.044*	0.011	0.034	−0.109**	1

* significant at 5% level of significance.

** significant at 1% level of significance.

Table 4. Logit regression: EM as independent variable and ownership structure as moderator

	Model 1			Model 2			Model 3
Outcome variable	FD			FD			FD
Moderator							Ownership structure
	β	Sig.	Exp(β)	β	Sig.	Exp(β)	β	Sig.	Exp(β)
EM	0.401	0.000	1.494	0.352	0.000	1.422	1.393	0.001	4.027
OwnSt				−8.010	0.000	0.000	−8.858	0.000	0.000
EM*OwnSt							−1.849	0.011	0.157
ROE	−0.531	0.000	0.588	−0.461	0.000	0.630	−0.462	0.001	0.630
Sze	0.088	0.002	1.092	0.103	0.001	1.109	0.103	0.001	1.108
Lvg	3.250	0.000	25.780	3.486	0.000	32.640	3.451	0.000	31.532
Lqdty	−0.365	0.000	0.694	−0.341	0.000	0.711	−0.366	0.000	0.694
Constant	−1.106	0.013	0.331	2.968	0.000	19.452	3.475	0.000	32.298
Cox & Snell R^2	0.126			0.291			0.294
No. of obs	2028			2028			2028

* significant at 5% level of significance, ** significant at 1% level of significance.

The effects of predictors and moderator on FD are on a log odds metric.

Table

Ownership structure items (OwnSt)
S. no.	Variable name	Definition/index scoring
1.	Large directors	No. of shares owned by largest shareholders divided by no. of shares issued. If large directors’ ownership is greater than its median, then scored 1, otherwise 0.
2.	Ownership concentration	No. of shares owned by top 5 shareholders divided by no. of shares issued (measured through Herfindahl Index, also known as Herfindahl-Hirschman Index, HHI). If ownership concentration is greater than its median, then scored 1, otherwise 0.
3.	Individual ownership	No. of shares owned by general public/individuals divided by no. of shares issued. If individual ownership is greater than its median, then scored 1, otherwise 0.
4.	Foreign ownership	No. of shares owned by foreigners divided by no. of shares issued. If foreign ownership is greater than its median, then scored 1, otherwise 0.
5.	Institutional ownership	No. of shares owned by financial institutions divided by no. of shares issued. If institutional ownership is greater than its median, then scored 1, otherwise 0.
6.	Joint stock ownership	No. of shares owned by joint stock companies divided by no. of shares issued. If joint stock ownership is greater than its median, then scored 1, otherwise 0.
7.	Associated companies ownership	No. of shares owned by associated or parent companies divided by no. of shares issued. If associated companies ownership is greater than its median, then scored 1, otherwise 0.
8.	Family ownership	No. of shares owned by family members divided by no. of shares issued. If family ownership is less than its median, then scored 1, otherwise 0.
9.	Family controlled	Dummy variable coded 1 if family ownership is 30% or more than 30%, zero otherwise. If family controlled dummy variable is zero, then scored 1, otherwise 0.
10.	Director ownership	No. of shares owned by directors divided by no. of shares issued. If director ownership is greater than its median, then scored 1, otherwise 0.
11.	CEO ownership	No. of shares owned by CEO divided by no. of shares issued. If CEO ownership is greater than its median, then scored 1, otherwise 0.
12.	Inside ownership	No. of shares owned by executives, directors and CEO divided by no. of shares issued. If inside ownership is more than 25% but less than 40%, then scored 1, otherwise 0.
13.	External block-holders	Dummy variable coded 1 if largest shareholder owns more than 10% of shareholding, zero otherwise. If there is presence of external block-holder, then scored 1, otherwise 0.
14.	Institutional activism	Dummy variable coded 1 if there is presence of nominee of financial institution, 0 otherwise. If there is presence of institutional activism, then scored 1, otherwise 0.