The relationship between managerial entrenchment, earnings management and firm innovation

Purpose - The purpose of this paper is to evaluate the qualitative effect of corporate governance components, in the form of managerial entrenchment index, on earnings management and innovation. Design/methodology/approach - In this study, the variable of managerial entrenchment, which includes the variables of management independence, dual role of management, management tenure, the board compensation and the board ownership percentage, was initially estimated through the exploratory factor analysis and its effect was evaluated on the dependent variables of the study using the test of multivariable regressions. Hence, a total of 103 listed companies on the Tehran Stock Exchange were selected and analyzed during 2011–2016. In this paper, the Jones model is used as the variable of accrued earnings management and for calculating the real earnings management, the models of abnormal operational cash flows, abnormal production costs and abnormal optional costs are employed. Moreover, the research and development cost to total costs ratio is used for calculating the innovation. Findings - The results indicate a negative and significant relationship between managerial entrenchment and accrual-based earnings management; moreover, the entrenched managers are less likely to engage in manipulating the real activities accruals in Iran context. Furthermore, the findings show that there is a positive and significant relationship between managerial entrenchment and firm innovation. Originality/value - What really sets this paper apart from other studies is that this research will make aware investors and stakeholders of this fact that managerial entrenchment will be a good way to diminish the manipulation of financial reporting and improve the corporate situation in emerging markets, particularly those bazaars facing with economic sanctions such as Iran. Undeniably, the study results will complete the knowledge gap between the developed economies and the emerging markets.