Contrary to our expectation firms with the lowest

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Unformatted text preview: hips in unaffiliated firms (NXDIRSHIP). Firms with the lowest discretionary accruals have larger boards, a result that may be explained by the fact that larger firms generally have larger boards and the possibility for larger boards to have more non-executive directors. Contrary to our expectation, firms with the lowest discretionary accruals do not 21 have non-executive directors with the highest monitoring incentive as measured by NXOWN. The highest value is for the high negative discretionary accruals firms. Out of the motivation control variables only IPO is significantly different across the earnings management categories, the lowest discretionary accrual firms being less likely to have an IPO in 1996. The other monitoring mechanisms are all significant, the lowest discretionary accruals firms are more likely to hire Big 6 auditors (BIG6) and have a larger percentage of outstanding common stock shares held by blockholders (BLOCK). Multivariate analysis Table 3 presents the results of the logistic regression model used to test the relation between discretionary accruals and governance characteristics. The models are highly significant (p = 0.0001), and the pseudo-R2 varies between 59 and 62 percent. Audit committee characteristics We test simultaneously for the effect of all the audit committee characteristics using a Wald test, and we find that it is statistically significant (χ2=19.7 df=7, p=0.006). As Table 3 shows, contrary to our expectations, the presence of earnings management is not related to whether the audit committee is composed solely of independent non-executive directors (ACIND). As alternative measures of committee independence, we use first the percentage of independent non-executive directors on the committee and then an indicator variable with the value of 1 if the committee has a majority of independent non-executive directors and the results (not shown in a table) are similar to those in Table 3. Contrary to studies examining situations of fraud, which found a significant effect for audit committee independence (Abbott et al. 2000), it appears that there is no meaningful direct relation between earnings management and the proportion of independent non-executive directors or, as proposed by the BRC 22 (1999), only independent directors on the committee. We find, however, that having more independent non-executive directors who are not managers in other firms (ACNMAN) is negatively related to both the absolute and positive levels of discretionary accruals. This result is consistent with the assertion that non-executive directors, if they are at the same time managers in another company, may be less inclined to criticize the firm’s management and to exercise their monitoring role (Westphal and Zajac 1997). It also provides archival evidence supporting the experimental findings of DeZoort and Salterio (2001) that these directors are more likely to support management in disputes opposing auditors and corporate management. As expected we find that the proportion of options that can be exercised in the short run in the independent directors’ holdings (ACOPTION) is positively related to positive discretionary accruals. While not significant, the negative effect on negative earnings management also supports the assertion that these options reduce independence. These results support the Cadbury Committee’s (1992, 4.13) suggested good practice that non-executive directors should not participate in share option schemes. The presence of at least one audit committee member with financial expertise (FNEXPERT), as recommended by the BRC, is negatively related to the level of earnings management. The effect, however, is only statistically significant for negative discretionary accruals.4 We find that an active committee is associated with less earnings management. Indeed, the presence of a clear mandate establishing the committee's responsibility for the oversight of both the financial statements and external auditing (MANDATE) is negatively related to the level of both positive and negative discretionary accruals. Hence, as proposed by the BRC, a formal charter does not only provide guidance to members as to their duties but is a source of power for the audit committee. This result with archival data supports the findings from a survey by Kalbers and Fogarty (1993) that a formal written charter plays an important 23 role in audit committee power and that perceived effectiveness of the committee is significantly related to this power. Contrary to our expectations, we find that meeting more than twice a year (MEETINGS) is positively related to positive earnings management (+1.845), but when it is put in interaction with independence (ACIND*MEETINGS) the combined effect (-2.733) is significantly negative. This suggests that an audit committee composed solely of independent non-executive directors who meet more than twice a year reduces positive earnings management, but that a non-independent committee that meets more...
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This document was uploaded on 11/27/2013.

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