Abstract

This research studies the impact of leverage on the earnings management levels of firms and investigates the role it plays in determining the choice of earnings management methods utilized by managers. This study is conducted within the context of European countries. Multiple panel regressions are run with leverage against various measures of earnings management. The results indicate that leverage curtails earnings management but this is only limited to discretionary accruals. Firms make a switch to real earnings management in cases of high leverage. The results indicate a positive impact of leverage on total earnings management and leverage moderates the choice between the two forms of earnings management. In the face of high leverage, managers make more use of real earnings management. This study broadens the scope of literature on leverage and earnings management by being the first study to investigate the impact of leverage on the total earnings management of firms and how leverage moderates the choice between the two forms of earnings management.

Key words: Earnings management, leverage, discretionary accruals, real earnings management, trade-off.