Earnings Management and Cost of Debt of Brazilian Privately Held Companies

Abstract We analyzed the relationship between earnings management and the cost of debt using a sample of 3,503 Brazilian privately held companies. In doing so, we discuss the fundamentals of earnings management and the specific economics of privately held companies in Brazil and then hypothesize how these relationships come about. Our proxies for earnings management were modified Jones and modified Jones with ROA (return on assets). We then ran their residuals as explanatory variables for the cost of debt. Our findings point to the importance of earnings quality in privately held companies and the impact of earnings management on the cost of debt, suggesting that the higher the levels of earnings management, the higher the cost of debt, even when controlling by other variables that can influence this relationship. Our findings may also serve to encourage privately held companies to concern themselves with the quality of accounting earnings and inhibit earnings management practices that could increase their cost of debt.