Credit Scoring, Earnings Management, and Voluntary Adoption of IFRS

Abstract. This study investigates the relationship between earnings management and credit scoring in private companies. Earnings management can be defined as the manipulation of financial statements by managers to meet or exceed analysts’ expectations or to avoid reporting poor financial performance. On the other hand, credit scoring is a method credit rating agencies use to evaluate a company’s creditworthiness. Unlike credit rating, credit scoring is an automated calculation of a company’s creditworthiness that does not require the qualitative assessment of a rating analyst. The accounting literature has developed several techniques to detect earnings management over the years, one of the components of the broader concept of earnings quality (Jones 1991, Dechow, Sloan, and Sweeney 1995, DeFond and Park 2001, Dechow, Ge, and Schrand 2010). IFRS are considered “investor-oriented” accounting standards, as opposed to most European national accounting standards, which can be defined as “creditor-oriented” (Nobes 1998). IFRS are generally considered high-quality standards that provide timely and relevant financial information. However, adopting IFRS per se does not necessarily lead to a decrease in earnings management and, thus, to an improvement in earnings quality. Findings so far have been contradictory (De George, Li, and Shivakumar 2016), and there is scarce literature focusing on private companies (Cameran and Campa 2020). Private companies, even though possibly benefiting from the lower scrutiny to which their financial statements are subject compared to listed companies, could still have incentives to manipulate their earnings, especially for better access to credit financing. By studying about 10,300 Italian private companies from 2017 to 2021, of which more than 900 are voluntary adopters of IFRS, we find a negative relationship between earnings management and credit scoring, meaning that companies that engage in earnings management practices receive lower credit scores than their peers. However, the choice to adopt IFRS voluntarily seems connected to lower credit scores despite the higher earnings quality exhibited by IFRS adopters. Finally, we also find that companies engaging in earnings management are more likely to improve their credit scoring, suggesting that private companies may have incentives to manipulate their earnings to get better access to credit financing.