The impact of board composition and family ownership on audit committee formation: Evidence from Hong Kong

This study investigates empirically the relationship between three major corporate governance attributes (family shareholding, non-executive directors and independent chairman) and the existence of audit committees across a sample of 397 publicly traded firms in Hong Kong. The results show that at a medium level of family shareholding (between 5% and 25%), the convergence-of-interest effect is dominant and the existence of audit committees decreases. At a high level of family shareholding (more than 25%), the entrenchment effect is dominant and as a result, the existence of audit committees increases. In addition, we show that the response of investors to audit committee existence is not dependent upon family shareholding when there is an independent chairman. The findings of our study also suggest that there is a positive association between the proportion of independent non-executive directors on the corporate board and audit committee existence. In addition, the results show that the positive association between independent non-executive directors is stronger for firms with an independent chairman. Implications of these findings for regulators are discussed.     

The association between management earnings forecasts, earnings management, and stock market valuation: Evidence from French IPOs

This study investigates managers' motivations to engage in earnings management through purposeful interventions in the setting of discretionary accruals, in the context of initial public offerings (IPOs) in France. Firms issuing forecasts in their prospectuses are expected to differ from nonforecasters in the level of earnings management during the year following the public offering. Within the context of contracting theory, four research questions are addressed. First, are IPO firms issuing forecasts more inclined to manage earnings 1 year after an IPO compared to nonforecasting firms? Second, is a forecasting firm's level of earnings management conditioned by earnings-forecast deviation? Third, is earnings management by IPO forecasting firms affected by contractual and governance environments? Fourth, how do investors see through earnings management following IPO earnings forecasts, i.e., how do stock market participants value earnings components (i.e., nondiscretionary and discretionary accruals)? Our findings document that in the year following an IPO, the magnitude of earnings management is much higher for forecasters than for nonforecasters. Results also show that a firm's accrual behavior is affected by earnings-forecast deviation, but the relationship is moderated by contractual and governance constraints. Finally, it would appear that French investors do not adequately readjust the relationship between reported earnings and a firm's market value for the year in which earnings are subject to manipulations.     

Impact of family dominance on monitoring of earnings management by audit committees: Evidence from Hong Kong

This study examines whether the establishment of audit committees by Hong Kong firms would constrain earnings management, especially in firms with family-dominated corporate boards, a condition unique to Hong Kong. The study uses the methodology of three-stage (3SLS) regression analyses to control for endogeneity among earnings management, voluntarily established audit committee, and corporate board size. The results of regression analyses based on 523 observations for the period of 1999-2000 when the audit committees were first established by Hong Kong firms show that overall audit committees play a significant role in constraining earnings management even in the business environment of higher ownership concentration. The effectiveness of audit committees is, however, significantly reduced when family members are present on corporate boards, especially when family members dominate the corporate board.     

Crossed-listed foreign firms' earnings informativeness, earnings management and disclosures of corporate governance information under SOX

The passage of the Sarbanes-Oxley Act (SOX) marks the beginning of the mandatory disclosure of audit-committee composition and other corporate governance information for cross-listed foreign firms. We posit that the provisions of SOX improve the effectiveness of an independent audit committee and other corporate-governance functions in monitoring the earnings quality of cross-listed foreign firms, and we use cross-listed firms' earnings informativeness and earnings management to measure earnings quality. Our findings show earnings informativeness is significantly associated with audit-committee independence as well as with board independence in the post-SOX period. In contrast, we do not find a significant association between earnings informativeness and audit-committee independence in the pre-SOX period. Our findings also show a consistently negative association between earnings management and audit-committee independence after SOX, an association that is not found in the pre-SOX period. Similarly, a negative association between earnings informativeness and the CEO duality as the chair of the board is only found in the post-SOX period. Furthermore, our results show a positive (negative) association between earnings informativeness (earnings management) and an aggregate corporate-governance score as a measure of overall corporate-governance functions in both the pre- and post-SOX periods. Our findings on the change of magnitude in the relationship between earnings informativeness (earnings management) and corporate governance suggest that the SOX provisions improve the effectiveness of cross-listed foreign firms' corporate-governance functions in monitoring the quality of accounting earnings.     

Deferred taxes,earnings management,and corporate governance: Malaysian evidence

This study examines whether Malaysian public listed companies (PLCs) use deferred taxes to avoid an earnings decline. In addition, this study also examines whether corporate governance mechanisms attenuate the extent to which deferred taxes are used to manage earnings. Using a sample of 221 PLCs listed on the main and second boards of Bursa Malaysia in 2008 with a complete set of data available from 2005 to 2008, this study finds that Malaysian PLCs use both the accrual and valuation allowance components of net deferred tax liabilities to avoid a decline in earnings. The study also finds that ownership structure and board structure affect the extent to which earnings management is associated with a deferred tax component.     

Corporate board and board committee independence,firm performance,and family ownership concentration: An analysis based on Hong Kong firms

This study examines whether the relationship between corporate board and board committee independence and firm performance is moderated by the concentration of family ownership. Based on a sample of Hong Kong firms, we find no significant association between the independence of corporate boards or board committees and firm performance in family firms, whereas board independence is positively associated with firm performance in non-family firms. Additionally, our findings show that the proportion of independent directors on the corporate boards of family firms is lower than that of non-family firms, but we find no significant difference in the representation of independent directors on the key committees of corporate boards between family and non-family firms. Overall, these results suggest that the “one size fits all” approach required by the regulatory authorities for appointing independent directors on corporate boards may not necessarily enhance firm performance, especially for family firms. Thus, the requirement to appoint independent directors to the corporate boards of family firms needs to be reconsidered.     

Is there information content from insider trading activities preceding earnings and dividend announcements in Hong Kong?

This study examines whether insiders (directors) exploit information advantage of their firms by trading stocks before the simultaneous earnings and dividend announcements in Hong Kong. Our findings show that there are significant net-insider-buying activities before the announcements of good news ('Earnings-Dividend Increase') and significant net-insider-selling activities before bad news ('Earnings-Dividend Decrease' and 'Earnings Decrease-Dividend Zero'). In addition, our regression results provide some support for the hypothesis that there is a predictive relation between pre-event insider trading activity and the abnormal return of the announcements.     

Internal governance structures and earnings management

This paper investigates the role of a firm's internal governance structure in constraining earnings management. It is hypothesized that the practice of earnings management is systematically related to the strength of internal corporate governance mechanisms, including the board of directors, the audit committee, the internal audit function and the choice of external auditor. Based on a broad cross‐sectional sample of 434 listed Australian firms, for the financial year ending in 2000, a majority of non‐executive directors on the board and on the audit committee are found to be significantly associated with a lower likelihood of earnings management, as measured by the absolute level of discretionary accruals. The voluntary establishment of an internal audit function and the choice of auditor are not significantly related to a reduction in the level of discretionary accruals. Our additional analysis, using small increases in earnings as a measure of earnings management, also found a negative association between this measure and the existence of an audit committee.     

Reversing an impairment loss and earnings management: The role of corporate governance

This paper examines whether the reversal of a previously recognized impairment loss provides an opportunity for earnings management, and whether such behavior is associated with managers' incentives. It also examines whether a corporate-governance mechanism can mitigate this behavior. Since 2005, listed companies in Taiwan have been required to comply with accounting standards, equivalent to International Accounting Standards (IAS) No. 36 “Impairment of Assets,” which allow reversals of asset-impairment losses. Data on a sample of 55 firms that reversed impairment losses between 2005 and the first quarter of 2007 were matched by industry and size with 55 control firms. Empirical results show that firms recognizing more impairment losses are more likely to reverse impairment losses when doing so would avoid an earnings decline in a subsequent period, which is consistent with the “cookie jar” reserve hypothesis. We also show that such behavior is more pronounced for firms with higher debt ratios, consistent with earnings management being associated with the incentive to avoid violation of debt covenants. However, an effective corporate governance mechanism could mitigate such behavior. Our study may contribute to the debate on global convergence with IFRS, especially convergence between IFRS and U.S. GAAP with respect to the “Impairment of Assets,” by providing a rationale for the latter's prohibition of reversals. It may also contribute to the corporate-governance literature by showing the effect of governance mechanisms on deterring earnings management.     

Corporate governance and earnings management in the Chinese listed companies: A tunneling perspective

This paper examines the relation between earnings management and corporate governance in China by introducing a tunneling perspective. We document systematic differences in earnings management across the universe of China's listed companies during 1999–2005, and empirically demonstrate that firms with higher corporate governance levels have lower levels of earnings management. We study two China-specific situations, in which the listed firms have strong incentives to manage earnings in order to meet certain return on equity (ROE) thresholds, and earnings management has been shown to be the most conspicuous. We identify tunneling evidence for each. Our empirical findings, although not being able to completely exclude other explanations, strongly suggest that agency conflicts between controlling shareholders and minority investors account for a significant portion of earnings management in China's listed firms.     

Debt,diversification and earnings management

In this article we use panel-estimation techniques to calculate discretionary accruals (DAC) and to produce a better understanding of the nature of the relation between debt and earnings management. Consistent with the transparency hypothesis (which suggests that diversification increases the complexity of firms’ activities and reduces their transparency to outsiders), we find that for less-diversified (more transparent) firms, debt reduces positive discretionary accruals, whereas in relatively more-diversified (less transparent) firms the impact of debt becomes positive. Our paper shows that marginal increases in debt provide the incentives for managers to manipulate earnings, and diversification provides the needed context for this accounting practice to be possible. We have also found that only in the sub-sample of aggressive firms, those that manage discretionary accruals with enough magnitude to increase income, do lenders exert their control. Some firms, however, take advantage of diversification to avoid this control. Our findings are robust to several earnings-management measures and methodologies.     

Board of director characteristics and earnings quality surrounding implementation of a corporate governance code in Mexico

Mexico recently enacted a corporate governance code. One objective of the code is to improve board of director oversight and to reveal more transparent information to shareholders by including detailed information regarding the structure of the board and its functions. Research in the U.S. has documented improvement in earnings quality associated with board characteristics. Whether or not board characteristics are associated with improved earnings quality in Mexico is questionable given the business environment in which firms operate, characterized by controlling family ownership and weak legal protection of property rights. The purpose of this study is to investigate whether or not board characteristics other than compliance with board independence (board composition disclosure, family concentrated ownership and shared-directors) are associated with the improvement in earnings quality found in previous research. Earnings quality is measured using income smoothing, timely loss recognition and conditional accruals. We find firms that do not have concentrated family ownership or share directors have greater increases in earnings quality than firms that have concentrated family ownership or share directors. We conclude that applying board-level corporate governance reforms, without considering cultural and legal environments, may limit the desired effects of the change.     

Corporate governance and earnings management at large U.S. bank holding companies

This paper examines whether corporate governance mechanisms affect earnings and earnings management at the largest publicly traded bank holding companies in the United States. We first find that performance, earnings management, and corporate governance are endogenously determined. Thus, OLS estimation can lead to biased coefficients and a simultaneous equations approach is used. We find that CEO pay-for-performance sensitivity (PPS), board independence, and capital are positively related to earnings and that earnings, board independence, and capital are negatively related to earnings management. We also find that PPS is positively related to earnings management. Finally, PPS and board independence are positively related and the relationship is bidirectional. While both PPS and board independence are associated with higher earnings, our results indicate that more independent boards appear to constrain the earnings management that greater PPS compels.     

Audit committees and earnings quality

This research investigates whether audit committees are associated with improved earnings quality for a sample of Australian listed companies prior to the introduction of mandatory audit committee requirements in 2003. Two measures of earnings quality are used based on models first developed by Jones (1991 ) and Dechow and Dichev (2002 ). Our results indicate that formation of an audit committee reduces intentional earnings management but not accrual estimation errors. We also find differences in the associations between audit committee accounting expertise and the two earnings quality measures. Other audit committee characteristics examined are not significantly related to either earnings quality measure.     

Corporate governance,earnings management,and IFRS: Empirical evidence from Chinese domestically listed companies

This research used 1,329 Chinese publicly listed companies’ data from 1998 to 2009 to investigate how IFRS, state ownership, and board of directors (BOD) influence earnings management. We conclude that state-ownership to an extent discourages earnings management in the current environment of China. However, IFRS implementation does not seem to deter earnings management. When state-ownership is not the case, increasing the number of independent BOD seems to be a good practice to discourage earnings management, although non-independent BOD does not make any difference.     

Family control and idiosyncratic volatility: Evidence from listed firms in Hong Kong

Family control of listed firms in Hong Kong is substantively different and materially higher than in the US which could offer different insights into the effects of family ownership on corporate transparency. Using a sample of listed Hong Kong firms and idiosyncratic volatility as a proxy for firm-specific stock price informativeness, we find that family firms exhibit higher idiosyncratic volatility of stock prices than similar non-family firms. Further, the relation between family ownership and idiosyncratic volatility is weaker for firms with higher leverage but stronger in periods before equity issues. Additionally, we find that family firms disclose more information, particularly related to operations, than nonfamily firms in annual reports. These results are consistent with the argument that family firms disclose more information than their nonfamily peers to reassure skeptical outside investors that they are not expropriating their investment.     

Earnings management and earnings quality

Viewing the detection of earnings management from the perspective of a crime scene investigator sheds new light on prior research on earnings management and its close relative, earnings quality. The works of Ball and Shivakumar [2008. Earnings quality at initial public offerings. Journal of Accounting and Economics, in press.] and Teoh et al. [1998. Earnings management and the subsequent market performance of initial public offerings. Journal of Finance 53, 1935–1974.] are used to illustrate the application of seven components of a crime scene investigation to earnings management research.     

Information asymmetry,mutual funds and earnings management: Evidence from China

This paper investigates how information asymmetry and mutual fund ownership affect listed companies’ earnings management. We show that (1) reducing information asymmetry improves firms’ earnings management behavior; (2) relative to short-term mutual funds, long-term mutual funds promote earnings quality by adopting a monitoring role; and (3) by dividing firms into high/low information asymmetry groups, we find that the information environment significantly increases the effect of long-term mutual funds on firms’ earnings management. In this paper, we provide new evidence for the role that institutional investors play in a typical emerging capital market. Our results have clear policy implications: to increase earnings quality, it is essential to improve information transparency and develop long-term institutional investors.     

Split-share reform and earnings management: Evidence from China

This paper investigates the impact of split-share structure reform on earnings management in China. A unique institutional feature of China was the co-existence of two types of share that endowed all shareholders with equal voting and cash flow rights but different tradability. This split-share structure significantly constrained the tradability of shares that led the Chinese Securities Regulatory Commission to make it mandatory for the conversion of non-tradable shares into tradable shares from 2006 onwards. We investigate whether such a conversion has any effect on information quality through reduced earnings manipulation. We specifically examine the incentives for earnings management during the reform-transition period. A unique feature of the split-share reform has been the requirement for non-tradable share holders to compensate the tradable share holders. We argue that the rational response from the non-tradable share holders would be to pay a lower consideration to tradable share holders by portraying a favorable picture through income-increasing earnings management. We also test for the effect of an increase in tradable shares on earnings management during the reform-transition and post-reform period.     

The association between corporate governance and earnings quality: Further evidence using the GOV-Score

This paper reexamines the relation between corporate governance and quality of earnings using a summary governance measure. Prior research has used many surrogates for corporate governance including size and composition of board of directors, existence and composition of audit committee, and extent of institutional ownership. However, the criticism of the extant research has been that corporate governance comprises many facets and is not uni-dimensional. In this study we fill this void by using the Gov-Score developed by Brown and Caylor [Brown, D., and Caylor, M.L., (2006). Corporate governance and firm valuation. Journal of Accounting and Public Policy 25, 409-434.] to measure corporate governance. In the post-Sarbanes-Oxley period, we find evidence of a significant inverse relationship, namely higher levels of corporate governance are associated with lower absolute discretionary accruals and higher quality of earnings. Furthermore, our results suggest that only firms in the highest category of corporate governance experience significantly improved quality of earnings. Finally, as a test of robustness, we document that corporate governance is negatively associated with small earnings surprises. This implies that firms with weak corporate governance are more likely to manage earnings in order to meet or beat analyst forecasts.