Influence of Advertising Intensity on Real Earnings Management: Evidence from Four Sectors of Pakistan

Abstract

The current study aimed to investigate the link between advertising intensity and real earnings management (REM) in the context of four sectors of Pakistan. Besides advertising intensity, market to book ratio, leverage, and firm size were included as explanatory variables. On the basis of data availability for the time period 2007-2019, 11 firms were selected from the Auto assembler sector, 6 firms from Auto parts, 16 firms from Food and Personal Care (PC), and eight firms from the Pharmaceutical sector. Data of the Auto assembler sector was analyzed by random effects panel data regression, whereas data of other three sectors was analyzed by fixed-effects model. In respect of Food and PC and Pharmaceutical sectors, the results of the present study indicate that the extent of REM increases with advertising intensity. Firms adopt the REM approach in order to show the positive outcome of large advertising expenditures. Additionally, a significant negative link between MBR and REM was noted for all sectors except Auto parts. Moreover, a significant positive link between leverage and REM was observed for all sectors except Food and PC. Also, a significant positive link between firm size and REM was noted for the Auto parts sector only. The present study is the first in Pakistan to investigate the link of advertising intensity with REM. This study has important implications for investors and regulators. Investors should carefully compare the firms of Food and PC and Pharmaceutical sectors with the other firms of respective sectors. Also, regulators shall make necessary modifications in the regulations to preclude firms from manipulating earnings. The focus of this study was on four sectors of Pakistan. Thus, the link between advertising intensity and REM can be tested for other sectors.