Impact of Free Cash Flow on Real and Artificial Earnings Management

Document Type : Research Paper


1 MSc. Student in Accounting, Faculty of Literature and Humanities, Islamic Azad University of Bonab, Bonab, Iran

2 Associate Prof., Faculty of Management, Economics and Accounting, Islamic Azad University of Tabriz, Tabriz, Iran


The purpose of this study is to examine the effect of free cash flow on the management of real and artificial earning in companies listed in the Tehran Stock Exchange during 2006 – 2016 by choosing 183 companies as sample. To test the hypotheses, multivariate linear regression with panel data has been used. In this study, free cash flows and real earnings management have been measured with two and three measures (earlier and latter measures respectively are free cash flows to the firm and business, and abnormal operating cash flows, abnormal production costs, abnormal discretionary costs and artificial earnings management though discretionary accruals). The results shows free cash flows with above mentioned criteria has a positive and significant impact on the criteria of real and artificial earnings management. That means with the increase in free cash flow, the irregular level of the criteria of real earnings management and also the amount of accruals items are increased. Actually the managers of the companies with high free cash flow have a good severity of action in manage of earnings management. Thus, the opportunist behavior of managers with surplus amount of cash can be explained through free cash flows theory.


Bhundia, A. (2012). A comparative study between free cash flows and earnings management. Business Intelligence Journal, 5 (1), 123-129.
Cardoso, F .Martinez, A. & Teixeira, A. (2014). Free cash flow and earnings management in Brazil: The negative side of financial slack. Global Journal of Management and Business Research: D Accounting and Auditing, 14 (1), 84-95.
Cohen, D. & Zarowin, P. (2010). Accrual-based and real earnings management activities around seasoned equity offerings. Journal of Accounting and Economics, 50 (1), 2-19.
Copeland, T., Koller, T. & Mrrinu, J. (1991). Valuation, measuring and managing the value of companies. Second edition, John wiley and Sons Publishing.
Dechow, P. M. & Skinner, D. J. (2000.( Earnings management. Reconciling the views of accounting academics, practitioners, and regulators Accounting Horizons, 14 (2), 235-250.
Fakhari, H. & Adili, M. (2012). The relationship between free cash flow and earnings management through real activities. The Iranian Accounting and Auditing Review, 19 (4), 63-78.
Foroozian, H. & Gaskari, R. (2016). Investigation the Effect of Cash Flow Volatility and Financial Leverge on Earnings Management in the Context of Listed Companies in Tehran Stock Exchange. International Journal of Humanities And Cultural Studies, Special Issue, 2216-2224.
Healy, P. & Wahlen, J. (1999). A review of the earnings management literature and its Implications for standard setting. Accounting Horizons, 13 (4), 365-383.
Izadiniya, N., Rabiei, H. & Hamidiyan, N. (2013). The relationship between financial leverage and real earnings management of listed companies in Tehran Stock Exchange. Journal of Accounting Progress, 5(1), 33-54.
Jaggi, B. & Gul, A. (2000). Evidence of Accrual Management: A Test of the free cash flows and debt Monitoring hypothesis. Working Paper,
Jensen, M.C. (1986). Agency costs of free cash flow, corporate finance and takeovers. American Economic Review, 76(2), 323-329.
Jones, J. (1991). Earnings management during import relief investigations. Journal of Accounting Research, 29(2), 193-228.
Leggett, D., Parsons, L. & Reitenga, A. (2009). Real earnings management and Subsequent operating performance. Working paper. Available in: http://
Lehn, K. & Poulsen, A. (1989). Free cash flow and stockholder gains in going private transactions. The Journal of Finance, 44 (3), 771-787.
Maham, K., Farajzade, A. & Hosayni, J. (2008). Free cash flow. Journal of Knowledge and Accounting Research, (4)13, 30–37. (in Persian)
Mahrani, S. & Bagari, B. (2009). Investigating effect of free cash flows and institutional investors on earnings management of listed companies in Tehran Stock Exchange. Journal of Accounting Research, 1(2), 51–64. (in Persian)
Nekhili, M., Ben Amar, I., Chtioui, T. & Lakhal, F. (2016). Free cash flow and earnings management: The moderating role of governance and ownership. Jurnal of Social Science Research Network, 13 (1), 1-33.
Rahimian, N., Akhoondzadeh, M. & Habashi, A. (2013). Investigating effect of earnings management on relationship between free cash flow and shareholder value. Journal of Knowledge audit, 1(1), 1-21. (in Persian)
Roychowdhury, S. (2006). Earnings management through real activities manipulation. Journal of Accounting and Economics, 42 (3), 335-370.
Saeedi, A., Hamidian, N. & Rabii, H. (2015). The relationship between real earnings management activities and future performance. Journal of Management Accounting, 6 (17), 45- 58.(in Persian)
Tavakkol Nia, A. (2017). Auditor industry specialization, free cash flow and earning management by related party transactions. The Iranian Accounting and Auditing Review, 23 (1), 63-78. (in Persian)
Veronica Siregar, S. (2008). Type of earnings management and the effect of ownership structure, firm size, and corporategovernance pactices. The International Journal of Accounting, 43(1), 1-27.
Zhao, Y., Chen, K. H., Zhang, Y. & Davis, M. (2012). Takeover protection and managerial myopia: Evidence from real earnings management. Journal of Accounting and Public Policy,31(1), 109–135.