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.     

Female tainted directors,financial reporting quality and audit fees

This paper examines the association between the presence of female tainted directors on corporate boards and audit committees and (1) financial reporting quality and (2) audit fees. Female tainted directors are defined as female directors who have been directors of the firms that have previously been involved in financial failures and integrity indiscretions. Using real earnings management and audit fees as proxies for effective governance and board reputation, we find that firms with female tainted directors have higher real earnings management and higher audit fees. However, since prior literature has demonstrated that audit fees are higher for firms with female directors because female directors demand better auditing, we corroborate a supply-side effect of auditors charging higher audit fees when female tainted directors exist. We demonstrate this by showing that while there is an association between audit fee and real earnings management, this association is higher for firms with female tainted directors. Arguably, the governance and reputational benefits of female directors on boards are negated if such directors have tarnished professional reputations.     

Board Characteristics,Firm Profitability and Earnings Management: Evidence from India

The present paper explores the association between earnings management and specific board characteristics and the firm's profitability in the Indian context. In India, the corporate ownership model is the promoter dominated shareholders model. This is the first study based on a panel data framework that employs a fixed effect model to control for time‐invariant endogeneity. It also contributes to the literature by exploring the role of the firm's profitability in transmitting the impact of audit committee independence on earnings management. The study finds that profitability is an important variable, as it moderates the association between audit committee independence and earnings management. Managers of a profit‐making company would have little need to modify their earnings. This signifies that independent audit committees are more effective monitors of earnings management in profitable firms than in non‐profitable firms. Independent directors with multiple directorships are also found to be ineffective monitors. The findings are of material significance to policymakers in analysing board effectiveness and earnings management and improving policymaking for corporate governance by using profitability and related variables.     

Board Monitoring and Earnings Management Pre- and Post-IFRS

In this paper, we address the question of whether the board of directors is more effective in constraining earnings management after the mandatory application of IFRS. Specifically, we explore how two board characteristics — board independence and (2) the existence of an audit committee impact earnings management. Our empirical results suggest that board independence and audit committees play an important and effective role in reducing earnings management after the introduction of IFRS and that the accounting regulatory framework significantly contributes to the effectiveness of the two corporate governance mechanisms. Our findings also confirm that a company's corporate governance characteristics remain an important determinant of earnings quality; therefore, an analysis of the effects of new regulations must consider firm-level determinants.     

Duration of equity overvaluation and managers’ choice to use aggressive underlying earnings disclosure and accrual-based earnings management: Australian evidence

This paper examines whether equity overvaluation duration influences managers’ choice of different earnings management mechanisms and how corporate governance and the Australian Securities and Investment Commission’s underlying earnings disclosure guidelines influence managers’ choices. The study samples Australian Securities Exchange 200 firms from 2009 to 2016. Findings show that on average, firms more likely engage in accrual-based earnings management in the early overvaluation stage. In later stages, firms more likely disclose underlying earnings aggressively to sustain overvaluation. Additionally, firms with a high proportion of independent directors on the board prefer to disclose underlying earnings aggressively to sustain the equity overvaluation; firms with a low proportion of independent directors prefer both accrual-based earnings management and aggressive underlying earnings disclosure to sustain the overvaluation. Moreover, firms that conform to the Commission’s underlying earnings disclosure guidelines use neither accrual-based earnings management nor aggressive underlying earnings disclosure to sustain overvaluation, but non-conforming firms use both mechanisms.     

An exploratory study of the effects of the European Union 8th Directive on Company Law on audit committees: Evidence from EU companies listed on the US stock exchanges

Member States in the European Union will be required to establish audit committees for all public-interest entities, according to the EU 8th Directive on Company Law. This EU 8th Directive creates a convergence of corporate oversight for both audit processes and financial reporting process and thus provides an opportunity to examine and contrast associations that exist among audit committee, board of directors characteristics with audit committee alignment, and the impact of such alignment on earnings management. Results of a logistic regression analysis suggest that firms with audit committees possessing greater financial expertise, with larger boards and more independent boards are less likely to engage in audit committee alignment while firms with audit committees possessing greater governance expertise are more likely to engage in alignment. In addition, we find that firms associated with audit committee alignment engage in less earnings management.     

Do minority acquisitions transfer better corporate governance practices? An analysis of UK's cross-border minority investments

This study examines the influence of minority shareholders on the transfer of corporate governance practices into companies in other countries where they invest. By analysing UK firms that acquired a minority ownership in foreign firms between 1993 and 2014, we find evidence of better corporate governance in the board structure of target foreign firms following UK firms taking a minority shareholding, the extent and nature of the changes varying depending on the quality of investor protection in the country the foreign target firm is located. Our findings contribute to the on-going debates on the spillover effect of better corporate governance practices via cross-border mergers and acquisitions as well as relationship between internal (board of directors) and external (country's quality of investor protection) corporate governance mechanisms.     

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.     

The Effects of Public Venture Capital Investments on Corporate Governance: Evidence From IPO Firms in Emerging Markets

This study examines the impact of public venture capital (hereafter PVC) investments on corporate governance of initial public offering (hereafter IPO) firms in emerging markets. Using data collected from Taiwan PVC investments during 1996–2005, we analyse three corporate governance features in IPO firms: earnings management, board characteristics, and excess control by controlling shareholders. We find that PVC‐backed firms use fewer accounting accruals in their IPO financial statements than non‐PVC‐backed firms. This result suggests that PVC‐backed IPO firms engage in less earnings management than non‐PVC‐backed IPO firms. We also find PVC‐backed firms tend to set up their boards with fewer non‐independent directors and supervisors at IPO. This result indicates that PVC‐backed IPO firms have better board structures than non‐PVC‐backed IPO firms. Finally, we find that controlling shareholders are less likely to exert excess control in PVC‐backed firms than in non‐PVC‐backed firms. Overall, our results indicate that PVC investments add value to new IPO firms not only in financing their capital needs but also in creating better corporate governance structures in emerging markets.     

The Influence of Country‐ and Firm‐level Governance on Financial Reporting Quality: Revisiting the Evidence

This paper examines how firm‐level governance and country‐level governance interplay in shaping financial reporting quality. Using IFRS adoption as a source of variation in firms’ reporting discretion, and a large sample of European firms that mandatorily switch to the new set of standards, we find that in countries with low enforcement and weak oversight over financial reporting, only firms with strong board‐level corporate governance mechanisms experience an increase in financial reporting quality, consistent with firm‐ and country‐level governance mechanisms being substitutes. However, in countries with high enforcement and strict oversight over financial reporting, firms with either strong or weak board‐level governance mechanisms experience an increase in financial reporting quality, even if the increase is larger for the former group. Overall, our findings indicate that in the debate about the effects of governance on the quality of financial reporting, it is important to consider both country‐ and firm‐level corporate governance mechanisms.     

The Effect of Board Diversity on Earnings Quality: An Empirical Study of Listed Firms in Vietnam

Previous studies have established that firms’ effectiveness can differ based on the differences among directors within a board, and between boards. However, studies have yet to establish the effectiveness of the diverse attributes of the board on firms’ quality of earnings in an emerging market setting such as Vietnam. This study investigates the effect of board diversity on earnings quality in a sample of Vietnamese listed firms. The two dimensions of board diversity measures in this study cover a wide range of structural and demographic attributes of board of directors, using a diversity‐of‐boards index (dissimilarities among firm boards, i.e., board structure) and a diversity‐in‐boards index (dissimilarities among directors within a board, i.e., demographic attributes of board members). Earnings quality is an aggregate measure compiled from four accounting‐based measures of earnings quality: accruals quality, earnings persistence, earnings predictability and earnings smoothness. We find a significant, positive linear relationship between diversity of boards and earnings quality, while the relationship between diversity in boards and earnings quality is non‐linear, with a U‐shaped curve.     

Does board gender diversity affect corporate cash holdings?

This paper examines whether board gender diversity affects corporate cash holdings using S&P 1500 index firms in the US for the period 2006–2015. We document a significantly negative relationship between board gender diversity and cash holdings. We also find a strong negative effect of female independent directors consistent with monitoring function. Moreover, in accordance with the critical mass theory, we find a negative effect of female directors’ presence and voice on cash holdings. Our findings are robust to alternative econometric specifications, alternative measures of cash holdings and corporate governance, difference‐in‐differences, propensity score matching, and two‐stage least squares. This study offers useful insights into the current global debate on gender diversity and its implications for firms.     

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 Agency Conflicts

I investigate whether corporate governance is associated with the level of agency conflicts in firms. I employ exploratory principal components analysis on 22 individual governance variables to obtain seven factors that represent the different dimensions of governance for a firm. I measure the level of agency conflicts in firms based on seven proxies for agency conflicts used in the literature. I find that firms with greater agency conflicts have better governance mechanisms in place, particularly those related to the board, audit committee, and auditor. I also find that the composition and functioning of the board, the independence of the auditor, and the equity‐based compensation of directors are significantly associated with firm performance, but primarily for firms with high agency conflicts. Overall, the results support the theory that the existence and role of various governance mechanisms in a firm are a function of the level of agency conflicts in the firm.     

The governance of risk management: The importance of directors’ independence and financial knowledge

We test the effects of the independence and financial knowledge of directors on risk management and firm value in the gold mining industry. Our original hand‐collected database on directors’ financial education, accounting background, and financial experience allows us to measure the effect of financial knowledge on risk management activities. We show that directors’ financial knowledge increases firm value through the risk management channel. This effect is strengthened by the independence of the directors on the board and on the audit committee. Extending the dimension of education, we show that, following unexpected shocks to gold prices, firms with financially educated directors are more effective in hedging than average firms in the industry. Firms that hedge more also attracts highly educated directors on their board and audit committee. As a policy implication, our results suggest adding the experience and education dimensions to the 2002 Sarbanes–Oxley Act and New York Stock Exchange requirements for better governance.     

An analysis of the effect of mandatory adoption of IAS/IFRS on earnings management

This paper examines whether mandatory adoption of international accounting standards, IAS/IFRS, by French companies is associated with lower earnings management. In addition, the impact of six factors that may be related to earnings management level are also considered: the independence and the efficiency of the board of directors, the separation of roles of CEO and Chairman of the board, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets.Based on a sample of 353 French listed groups relating to the period 2003–2006, our results show that the mandatory adoption of IAS/IFRS is associated with a reduction in the earnings management level. In addition, the independence and the efficiency of the board of directors, the existence of an independent audit committee, the existence of block shareholders, the quality of the external audit and the listing on foreign financial markets are important factors for enforcement of IAS/IFRS in France. Mandatory adoption of IAS/IFRS has decreased earnings management level for companies with good corporate governance and those that depend on foreign financial markets.     

Small firms and the value of improvements in corporate governance mechanisms

Since 2002, many firms have been required to alter their board of directors and committees to increase management monitoring. Kinney and McDaniel (1989) and Chhaochharia and Grinstein (2007) provide empirical evidence suggesting that investments in corporate governance may differ based on firm size, and that under-investing in monitoring may be more pronounced in smaller firms. To further test whether the benefits of recent changes in companies' governance mechanisms accrue to smaller firms that have underinvested in governance, we examine the stock market reaction to changes in board structure over the twenty-four months following the passage of the Sarbanes–Oxley Act. We construct a new composite measure of board structure and regress buy-and-hold abnormal returns on changes that occur in the Board Structure Index, finding that improvements in corporate governance quality result in economically significant abnormal returns accruing only to the smaller firms with weak initial board structures.     

What is the Relationship Between REIT Governance and Earnings Management?

The empirical corporate finance literature claims that better corporate governance constrains earnings management, while others argue that the unique legal and reporting structure of REITs may reduce the need for such internal corporate governance. Using a sample of publicly traded REITs for the 2004–2008 time period, we examine the relationships amongst corporate governance, accruals earnings management, manipulation of Funds from Operations (FFO), and real earnings management. We find that corporate governance quality is unrelated to accruals earnings management and manipulation of FFO. At first glance, the findings suggest that managers need less internal oversight because of the more transparent reporting structure of REITs. However, we document that REITs engage in significant real activities manipulation for earnings management purposes. Our empirical findings further show that corporate governance characteristics, in particular board size, independence, number of board meetings and audit committee financial expertise, are essential for constraining such activities. Finally, by focusing on a subset of REITs that act in ways which previous research has identified as more susceptible to earnings management activities, we demonstrate that good corporate governance effectively reduces accruals earnings management and manipulation of FFO for these REITs. Overall, our findings indicate that, despite the unique legal and reporting structure, REITs engage in certain forms of earnings management, and that the ability for REITs to manipulate earnings is reduced when corporate governance is more effective.     

Earnings management and corporate governance: the role of the board and the audit committee

We examine the role of the board of directors, the audit committee, and the executive committee in preventing earnings management. Supporting an SEC Panel Report's conclusion that audit committee members need financial sophistication, we show that the composition of a board in general and of an audit committee more specifically, is related to the likelihood that a firm will engage in earnings management. Board and audit committee members with corporate or financial backgrounds are associated with firms that have smaller discretionary current accruals. Board and audit committee meeting frequency is also associated with reduced levels of discretionary current accruals. We conclude that board and audit committee activity and their members' financial sophistication may be important factors in constraining the propensity of managers to engage in earnings management.