Capital structure and earnings management of private enterprises: evidence from the transitional economy of laos

Capital structure and earnings management of private enterprises: evidence from the transitional economy of laos

A vast majority of prior empirical studies exclusively investigates the determinants of capital structure and earnings management of private and public firms
in developed and developing economies, but there is a shortage of works related to private firms in least developed countries with transitional economy. This empirical study attempts to extend the existing literature and fill the gap by examining financing decision and earnings management activities of private enterprises in the transitional economy environment from a centrally-planned regime to a market-oriented economy of Laos.

This study uses previous empirical works and theoretical principles related to private and public companies in developed, developing and other transitional economies to uncover the financing decision and earnings management activities of Lao private enterprises. The works and principles are used as a fundamental framework to understand previous related works and to formulate six hypotheses of this investigation. This study relies on two capital structure theories, the Pecking-Order theory and Trade-Off theory to explain the financing decision of the firms. Agency theory is also applied to explain the earnings management activities in relation to financial leverage of the enterprises. The earnings management is measured by using the Modified Jones Model and the Performance-Augmented Model. In conjunction, this study employs multiple linear regression models to statistically test the six formulated hypotheses under three research questions. The statistical data used in this study are drawn from annual financial reports of 224 private enterprises in Laos, containing 674 observations for five-year period of 2009-2013. The financial reports were prepared under the Lao accounting manuals and instructions.

This study contributes to several findings that reflect an under-developed transitional nature of the Lao business environment to the existing knowledge. First,
the modern Pecking-Order and Trade-Off theories as well as the firm-specific determinants and industry factors of capital structure derived from the developed and developing countriesare partially portable to financing decision of private enterprises in Laos. As in other countries, larger firms in Laos can easily access to external debt than smaller counterpart, whereas profitable firms are more likely to have less leverage and their retained earnings are primary source of investment. Empirically, the financing choices of Lao private firms seem to follow a limited Pecking-Order – retained profit, and total-debt. In addition, in line with the Trade-Off theory, Lao private firms across industry sectors differently adjust their capital structure to seek for an optimum level of debt-equity ratio. Second, with regards to the main determinants of earnings management, larger enterprises in Laos are more likely to engage in earnings management than smaller firms, whereas enterprises with higher level of tangibility and profitability tend engage in less earnings management. In addition, this study finds that sole-traders enterprises with more operating cash flow engage more in earnings manipulation. Further, the influence of firm size, tangibility, profitability, total revenue, and trade receivables on earnings management vary across industry sectors. Finally, earnings manipulation has a positively significant impact on financial leverage of Lao private enterprises, implying that the firms use financial leverage as a governance mechanism to mitigate opportunistic behaviour of managers.