Examining the Non-monotonic Relationship between Earnings Management and Firm Performance : Evidence from Panel Threshold Regression Approaches

The purpose of this study is to examine the effect of earnings management (EM) on firm financial performance contingent on corporate governance quality (CGQ) systems of firms in sub-Saharan Africa during the period 2007–2019. The study adopts a blend of analysis techniques ranging from static and dynamic linear to nonlinear threshold approaches through fixed-effect and GMM using annual panel data collected across 52 firms from nine sub-Saharan African countries over a period of 13 years. The study analyzes its models in a stepwise sequential manner so as to demonstrate the non-monotonic behaviour in the EM – firm performance relationship. By using CGQ as a threshold variable, the results show new findings of the performance effect of EM contingent on a uniquely identified CGQ threshold. The study finds that the performance-enhancing effect of EM is realized only when a firm’s CGQ reaches or exceeds the optimal threshold. Below this threshold, the effect of EM on performance is negligible or sometimes adverse. The estimated nonlinear effect of EM on firm performance and the threshold of CGQ can be benchmarks for Africa and other emerging and developing countries in assessment of their situations. The findings suggest important implications to investors as well as securities and capital market regulators of sub-Saharan Africa as they decide on policies to adopt so as to attain acceptable levels of CGQ for firms in order to avoid the detrimental effects of inadequate CGQ while reaping the benefits of adequate CGQ including limiting opportunistic EM, and boosting the efficiency outcomes of EM practices of firms