Examining the Threshold Effects of Corporate Governance in the Relationship between Investment Cash Flow Dynamics, Financial and Business Cycles of Listed Companies, and Earnings Quality

Abstract

The present study aims to examine the threshold effects of corporate governance in the relationship between investment cash flow dynamics, financial and business cycles of listed companies, and earnings quality. From the perspective of its objective, the study is applied in nature, and in terms of methodology, it follows a descriptive–analytical approach. The analysis is conducted using panel data from listed companies over the period 2011 to 2024. After applying screening criteria, a total of 106 companies were selected as the final sample and subjected to empirical analysis. Earnings quality is measured using discretionary accruals, while investment cash flow dynamics and financial and business cycles are assessed using standard indicators widely employed in the financial literature. In addition, a composite corporate governance index is constructed based on nine components, including board size and independence, gender diversity, board tenure, the existence of specialized committees, executive compensation, and institutional ownership. These components are reduced to a single index using the Principal Component Analysis (PCA) method. Prior to model estimation, the stationarity of variables is examined using the Levin–Lin–Chu unit root test, the results of which indicate that all variables are stationary at levels. Furthermore, the Kao panel cointegration test confirms the existence of a long-run equilibrium relationship among the study variables. To investigate nonlinear and threshold relationships, the Panel Smooth Transition Regression (PSTR) model is employed. The results of linearity diagnostic tests reveal that the relationships among the variables are nonlinear in nature, and that a logistic transition function with a single threshold is sufficient to capture this behavior. The findings from the PSTR model estimation indicate that investment cash flow dynamics and financial cycles have a positive and statistically significant effect on earnings quality, whereas firms’ business cycles exert a negative and significant impact on earnings quality. Moreover, corporate governance, as the transition variable, plays a reinforcing role in this relationship, such that once the corporate governance index exceeds the estimated threshold level, the magnitude of the explanatory variables’ effects on earnings quality increases significantly. These results suggest that improving corporate governance structures through enhanced transparency, reduced agency problems, and strengthened monitoring mechanisms can facilitate more efficient management of investment cash flows and better alignment of financial and business cycles, ultimately leading to improved earnings quality. By extending the literature on nonlinear relationships in corporate finance, the findings of this study provide valuable implications for managers, investors, and policymakers in promoting more efficient decision-making and enhancing the sustainability of corporate performance.