The Impact of Corporate Governance Quality on Earnings Management: Evidence from European Companies Cross‐listed in the US

The study reported herein examines the impact of two central corporate governance mechanisms (internal audit function quality and board of directors’ quality) on the incidence of earnings management. Unlike most prior studies in the area, focused mainly on US firms, this study looks at European firms that are cross‐listed in the US and covers a long time span – before and after major changes were implemented in corporate governance policies (Sarbanes‐Oxley Act in the US and the 8th Company Law Directive in the European Union). Using novel and comprehensive measurement approaches for internal audit function quality and board of directors’ quality, we find that both mechanisms have a negative direct effect on the incidence of earnings management, while their interactive effect is positive. A longitudinal analysis of both mechanisms also reveals that internal audit function quality and the quality of boards of directors have increased significantly since the policy changes.     

Audit committees and financial reporting quality: The 8th EU Company Law Directive perspective

In order to increase corporate governance quality, the 8th EU Company Law Directive enacted a mandatory audit committee in publicly listed companies in the EU and defined its tasks and responsibilities. In response to the directive, we examine the incremental value of audit committee monitoring effectiveness and audit committee competencies over the mere existence of an audit committee. We find that audit committee monitoring effectiveness and competencies are positively associated with financial reporting quality, whereas, somewhat surprisingly, the effect of the existence of an audit committee is negative. This finding shows that the existence of audit committees is a necessary but not a sufficient condition for enhancing financial reporting quality. Collectively, the study’s findings suggest that the 8th Directive has had a positive effect on corporate governance quality and, in turn, financial reporting quality in the EU.