The results presented in financial statements do not always accurately reflect a company’s actual performance. One of the reasons is the application of earnings management practices, which are also common among Lithuanian companies. The study identified key factors that increase the risk of earnings manipulation, such as financial leverage, profitability, gross domestic product, inflation, and unemployment rates. The findings indicate that companies engage in earnings management in response to changes in the macroeconomic environment and under financial pressure. These insights can contribute to a better understanding and evaluation of corporate behavior during periods of economic uncertainty, especially when assessing the reliability of financial results.

Introduction

Earnings management refers to the deliberate manipulation of financial results with the aim of influencing stakeholders’ decisions or shaping a desired corporate image. As the business environment becomes increasingly volatile, it is important to assess whether macroeconomic challenges – such as declining purchasing power or rising costs – can prompt companies to engage in earnings management practices. These factors may lead not only to lower revenue or profitability but also to increased insolvency risk, making the analysis of economic instability particularly relevant. However, empirical research examining the relationship between earnings management and changes in the macroeconomic environment remains limited. This issue is especially relevant for small, open economies such as Lithuania.

Research Objective and Methodology

The aim of the study was to identify which macroeconomic and firm-specific factors influence the application of earnings management in Lithuanian companies. The analysis included the financial statements of 186 large and medium-sized Lithuanian companies over a five-year period. Modified versions of the Jones model modified by Dechow et al. (1995) and Roychowdhury (2006) models were applied to identify earnings management. The study assessed macroeconomic indicators such as gross domestic product, inflation, and unemployment rates, as well as company-level financial indicators, including return on assets (RoA), financial leverage (LEV), and earnings before interest and taxes to margin (EBIT margin). To evaluate the influence of macroeconomic factors on earnings manipulation, three regression models were constructed: accrual-based earnings management with income-decreasing strategies (EMdec), accrual-based earnings management with income-increasing strategies (EMinc), and real earnings management (REM).

Key Findings

The study revealed that a company’s propensity to manipulate financial results is primarily driven by its financial structure and the macroeconomic environment. Analysis of the three models covering both accrual and real earnings management showed several clear patterns.

The most significant factor influencing the use of earnings management was financial leverage (LEV). In all models, companies with higher debt levels were more likely to apply earnings manipulation techniques. The findings confirm that firms under greater debt pressure tend to adjust their financial indicators to maintain credibility in the eyes of creditors.

Return on assets (RoA) and earnings before interest and taxes to margin (EBIT margin) were found to have a significant effect, particularly in cases where companies opt for income-increasing strategies. In other words, companies with lower profitability are more likely to adjust their reported performance to present a more stable financial position. When EBIT margin is low, the likelihood of engaging in real earnings management increases.

Slowing GDP growth, rising inflation, and higher unemployment rates can also incentivize earnings management, as companies aim to preserve a stable image and report higher profits. Firms tend to adopt different earnings management strategies depending on their financial condition and the macroeconomic environment. Low profitability, especially lower EBIT margin, is associated with a higher likelihood of income-increasing strategies – both accrual-based and real earnings management. In addition, macroeconomic indicators (GDP, inflation, unemployment) significantly influence accrual-based earnings management when the strategy is aimed at increasing reported income. This suggests that both firm-specific financial indicators and broader economic conditions contribute to opportunistic accounting behavior.

Discussion and Implications

The findings suggest that earnings management behavior in Lithuanian companies often emerges as a response to pressure – both internal (financial) and external (economic). It is not crises themselves, but their impact on company profitability and capital structure, that drive firms to adjust their results. Thus, earnings management becomes an opportunistic yet predictable reaction to an unfavorable context.

These findings offer practical implications for different stakeholder groups. Managers should proactively prepare for potential periods of economic uncertainty by developing transparent communication and accounting strategies. Auditors and financial analysts are advised to assess corporate behavior within the broader context of sector-specific sensitivity and prevailing macroeconomic pressures. For investors, it is important to monitor signs of earnings management, particularly in companies experiencing profitability stress or high financial leverage.

Finally, while short-term profit adjustments may help address immediate operational challenges, they also pose long-term reputational and financial risks. Sustainable corporate trust is not built on adjusted figures, but on results supported by clear, consistent, and contextually grounded business logic.

References

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Authors note:

This article is based on the findings of the author’s previously published academic research. The content has been adapted, rewritten, and reframed for a professional and business-oriented audience. The article is original and has not been published in this format elsewhere.