Do financing constraints affect the financial integrity of firms?

Abstract

We use micro-survey data from 126,309 private non-financial firms in 138 developing nations during the period of 2006–2018 to investigate how financing constraints affect the integrity of their financial information. Our findings indicate that private firms with greater financing constraints are less inclined to undergo external audits voluntarily. This effect varies depending on factors such as firm size, business sector, ownership structure, accounting and auditing conditions, as well as the prevailing institutional environment. Our results remain robust even after subjecting them to various sensitivity and endogeneity tests. They suggest that financially constrained firms in developing countries may have stronger motivations to manipulate earnings, employ aggressive tax avoidance strategies, or be susceptible to managerial short-sightedness. Additionally, it is possible that finance providers rely on alternative mechanisms rather than audited accounts to monitor firm performance.

Keywords: Developing countries, Financial integrity, Financing constraints, Institutions