Free Cash Flow and Earnings Management in Brazil: The Negative Side of Financial Slack
The article investigates whether Brazilian firms with excess free cash flow (FCF) and low growth perspectives (Jensen. 1986), when there is excess FCF, accompanied by limited growth perspectives, managers have incentives to camouflage the impact of investments in projects with negative net present value (NPV) by presenting inflated profits. The study includes firms listed on the BMF&Bovespa in the period from 2008 to 2012. Discretionary accruals (DA) were estimated by the modified Jones model and then the relationship between FCF and DA was ascertained by multiple regression. The results indicate that firms with low growth perspectives and excess FCF are more likely to manage earnings to increase profits. Shareholding concentration and adoption of IFRS moderate this relationship (FCF x DA), i.e., in practical terms they restrict the propensity to engage in this type of earnings management. This study is relevant by identifying a tendency to manage earnings. Regulators and investors should pay particular attention to the accounting results disclosed in the presence of excess free cash flow and low growth perspectives.
