1.

RESEARCH TOPIC:
The Relationship between Total Debt and Earning Management: Evidence from Banking Sector
of Pakistan.
2. INTRODUCTION:
Reporting and transferring accurate information to the decision making department and in front
of shareholder is of vital importance. The financial statements and the decision, is then based on
the information which is provided to the managers. Similarly, for the shareholders, their decision
will be based on the information which they will get through financial statement.
The earnings of any organization are very important for the shareholders and investors because
they have to invest based on the financial position of that organization. So true financial
reporting will be beneficial for the firm and as well as for the investors.
Some of the firms for example 3.com defaults due to reporting the wrong figures of their
earnings. It is believed that these defaults, many of more firms defaults due to reporting wrong
earnings, and basis of reporting wrong figure was their increased debt. Reporting the future
profits in current year, to show positive image to the investors, so they will invest more in that
organization.
Behind the earning manipulation it is believed that the liabilities of any firms are the reason.
When a firm has liabilities more than their assets and they do not able to meet the obligations
then they use earning management techniques to attract more investors to overcome their
liabilities.
So, primary objective is to find out the impact of total liabilities, of any bank, on earning
management. Due to the increase in liabilities the management of the banks uses earning
management techniques to manipulate their earnings.
We will use the data of top 10 banks from the state bank of Pakistan, and will use the data from
their financial reports to find out the desired values, and using the research tool we will find out
the relation between total liabilities and earning management.
To find out the total debt we will take the value of total liabilities from the balance sheet of the
banks, and to find out the earning management we will use specific method to calculate its value.

3. LITERATURE REVIEW:
According to Peit , Heidi and Marleen in their research paper earning management and debt
concludes that different dimensions of debt have different relation with earning management.

They have divided debt to A/p, bank loans, equity issue, taxes, and rent and then individually
effect of their on earning management. Still they had not used the basic liabilities; they have used
indirect or basic expenses as a proxy for the liabilities. They have not focused rest of the
dimensions which can be the reason for the increase of total liabilities. They conclude that the
A/p have very weakly but significantly related to the earning management. Bank loan is highly
significantly related to the earning management.
For my research the overall, sum of all liabilities wither short term, long term, loans, A/p are
taken as a total liabilities and then its effect on the earning management. The gap found in this
research that they have restricted the dimensions of total debt. Rest of the dimensions will be
covered, if we use the total liabilities, instead of individual dimension.
According to Peterand jose (2007) in their research paper earning management to avoid loses: a
cost of debt explanation concludes that the firms with the higher need of debt uses the higher
earning management techniques. Bu they have used 3 different time phases to measure the effect
of both variables. Three phases are: Bad news (BN), good news (GN) and (BN and PRIOR)
period. Their findings were that the higher manipulation was in BN and PRIOR period rather
than BN in general.
BN is basically when the firms facing bad reputation, BN and PRIOR means where the firm
facing bad reputation now but their reputation was good before, and GN means good new or
good reputation for the firm. They have used three time periods instead of measuring the effect
of total debt on earning management in general.
4. PROBLEM STATEMENT:
It is already research many times that banks debt had significant relation with the earning
management. But different proxies had been used to explain the dimensions of total debt like
basic expenses that are somehow liabilities of banks are used as proxy. Instead of using those
proxies to explain the total debt for the banks, we will use total liabilities from the balance sheet
to explain the total debt, which includes all the short term and long term obligations for the
banks. Similarly, we will test their relation in general not specifically in a defined time period.
5. RESEARCH QUESTION:
Does increase in total debt leads to the occurrence of earning management process in banking
sector of Pakistan?
6. HYPOTHESIS:
H0 =There is no relationship between total debt and earning management.
H1= There is a relationship between total debt and earning management.
7. THEORETICAL FRAMEWORK:

The objective of this study is to examine whether the earning management is affected by total
debt or not. This model shows the name of variables used in regression analysis.

TOTAL DEBT
(Independent variable)

EARNING MANAGEMENT
(Dependent variable)

Total
Accurals

Theoretical frame work of this study is developed to test the relationship between total debt and
earning management. This model helps us to understand the direction of effect or in simple
words identification of dependent and independent variables.
8. OPERATIONAL DEFINATION OF VARIABLES:
Earning management:
Earning management is a generic term used in finance or accounting decisions that changes
financial reporting outcomes. These techniques are used to manipulate the real figures or
earnings.
Earning management is measured by total accruals and discretionary accruals.
TA= CA - CL -CASH + (STDEBT-DEP)
CA = current assets
CL = current liabilities
STDEBT = short term debt
DEP = depreciation
Total debt:
The aggregate of all debts an individual or a company is liable for. Total liability can easily be
taken from the balance sheet of any company.

9. METHODOLOGY:
This research is based on positivism approach, as far as we are looking for some specific effect,
whether there is any relationship between total debt and earning management process or not?
We will here in this research, use the deductive approach as we have to reach at one point by
rejecting or accepting the null hypothesis.
Experimental strategy we will use in this research to determine the output/ result on a specific
selected or target population.
We will use the time series data from 2009- 2013 i.e. longitudinal aspect.
To test our hypothesis we will use the secondary data of 10 different banks, using their financial
statement for the time period 2009-2013.
10. EXPECTED OUTCOME OF THE STUDY:
We will try to find out that many organization which are using the earning management
techniques, and many firms which leads to default, had the main reason behind their earning
manipulation i.e. their total liabilities which increases from their total assets and then the firm is
unable to pay its liability back, and use those technique to survive as long as they can.
11. SIGNIFICANCE:
The contribution of this research paper is that the shareholders and other investors which are
interested in investing different banks can use this information to understand the basic factor
behind manipulations, misrepresentation and misspecification, if any.
For the auditors this study will help them to know the basis of earning management in any
organization, if occurs.
12. LIMITATIONS:
For this research top 10 banks are selected instead of overall population.
Total liabilities are used to explain the total debt, without adding the equity portion and expenses
as a liability.
To measure the variable i.e. earning management I have used only one dimension which is total
accruals instead of using both techniques.
Not covering the time period or firms reputation phase where the earning management is
expected to be very high, but in general.
13. FUTURE AREA OF RESEARCH:
Banks other form of liability which is in the form of dividend that a bank needs to pay to their
shareholder is not the part of this research.

Basic expenses along with total liabilities and total equity, which will be said as a weighted
average cost of capital (WACC), can be used to further check the factors behind earning
management.
Researcher can utilize this study for future research in this area, where they can change the
sector, where they think earning management takes place.
14. TIME FRAME:
15. REFERANCES:
Piet Sercu, H. V. (October 2006). Earnings management and debt.
Pope, J. A. (April 2007). Earnings Management to Avoid Losses: a cost of debt
explanation.Journal of Accounting and Economics.
16. ANEXURE