Earnings Quality Index, Political Connections And Firm Performance

Abstract

An efficient monitoring by an effective board can correlate the firm performance. The main purpose of this study is to examine the interaction of political connections and earnings quality on firm performance in Pakistani non-financial sector. The results show that politically connected firms have lower earnings quality. Using a sample of 114 actively trading firm on PSX for the period of 2011-2021, GMM estimates for panel data has been used. The significant and negative coefficient of interaction between earnings quality index and political connection shows the negative effect of manipulating earnings on all three performance measures of firms (ROA, ROE & PM) having politically connected directors as their board members. The results are consistent and support the prior research that Pakistani corporate sector has great influence of political connections. An interesting findings of this study are that this influence on accounting numbers is the reason behind financial crisis. Firms with political affiliations involve more in accrual earnings manipulations to improve financial numbers. These findings reveal that non-connected firms perform better than connected firms. Overall, the findings of this study are helpful for stakeholders, investors, supervisory and regulatory bodies to analyze the financial reports of politically connected firms even after the implementation of code of corporate governance and in improving financial reporting quality. Theoretically, the results support Agency theory and resource dependency theory.