Macroeconomic Stress, Earnings Management, And Financial Reporting Quality: Evidence From Psx-Listed Firms Using Benford's Law

Abstract

This study investigates the relationship between macroeconomic stress and financial reporting quality among non-financial firms listed on the Pakistan Stock Exchange (PSX) using Benford's Law as a digit-pattern diagnostic. Drawing on a sample of 324 continuously-listed non-financial companies spanning 29 sectors over the period 2014–2024, first-digit distributions from 3,288 revenue and 2,415 net income observations are extracted and tested against Benford's expected logarithmic distribution using five complementary statistical procedures. Revenue figures conform closely to Benford's Law, indicating natural reporting patterns. Net income exhibits statistically significant digit irregularities, most prominently an over-representation of digit 7 and under-representation of digit 6, consistent with systematic upward rounding near reporting thresholds. These irregularities intensify markedly during Pakistan's 2018–2021 economic crisis, with the composite Benford Digit Score rising 44.5 percent above non-crisis levels and the Distortion Factor Model reversing sign—from income inflation in stable periods to income suppression during stress. Revenue non-conformity in heavily regulated sectors reflects structural pricing constraints rather than managerial manipulation, providing a methodological refinement with direct relevance for regulators and analysts. The study contributes to the emerging-market financial reporting literature by establishing Benford's Law as a cost-effective screening instrument for identifying time periods, sectors, and firms with elevated reporting risk, with specific implications for the Securities and Exchange Commission of Pakistan (SECP), external auditors, and equity investors.