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Unformatted text preview: than twice a year will not result in more effective monitoring. On the contrary, it appears to be associated with more earnings management. Hence, an independent audit committee as per the BRC recommendations does not seem to be sufficient; the committee must also be active. Unfortunately, the BRC has no recommendations as to the number of meetings. It has, however, some recommendations dealing with the duties of the audit committee, the completion of which would probably be correlated with the frequency of the meetings. Board of director characteristics We test simultaneously for the effect of all the board of directors’ characteristics using a Wald test, and we find that it is statistically significant (χ2=13.1 df=7, p=0.069). As indicated in Table 3, having a larger board (BOARDSIZE) is associated with less earnings management, although the association is significant only for income-decreasing discretionary accruals. Thus, contrary to the results for financial statement fraud (Beasley 1996; Abbott et al. 2000), large boards seem to monitor the financial statement process more effectively. The median board size (shown in Table 2) of eight members for the low earnings management firms, compared to 6 for the two high earnings management groups, suggests that the 24 efficiency gains of small boards might be offset by the possibility that if the board is larger the proportion of non-executives may be higher. Contrary to our expectations, a higher percentage of non-executive independent directors on the board (BOARDIND), the combination of the roles of chair and CEO (CEOCHAIR), and a majority of non-executive directors on the nominating committee (NOMCOM) seem to have no effect on the level of earnings management. Consistent with Beasley (1996) we find that non-executive directors’ ownership stake in the firm (NXOWN) seems to significantly decrease the likelihood of negative earnings management (coefficient of –3.952). On the other hand, the coefficient of NXOWN is positive, though not significant, for positive earnings management (5.020). This may indicate that board members who own shares in the firm are not necessarily more effective at monitoring the financial statements preparation but more inclined to discourage actions that would reduce shareholder wealth. Both board competence characteristics are significantly related to the level of earnings management. The average tenure on the company board for non-executive directors (NXTENURE) and the average number of directorships they hold in unaffiliated firms (NXDIRSHIP) are negatively associated with the level of earnings management. These results support the view that experience as board members both with the firm and with other firms allows non-executive directors to develop better governance competencies as well as providing them with a better knowledge of the firm and of its executive directors. Of the two variables included in the models to control for specific motivations for earnings management in 1996, only the occurrence of an IPO in the year has a significant relationship with the level of discretionary accruals. Bonus plans and high debt ratios (AGENCY) don’t seem to provide incentives for earnings management in our sample. 25 As for the variables controlling for alternative control mechanisms, the type of auditor (BIG6) does not seem to affect the relationship between corporate governance and earnings management, but the presence of large shareholders (BLOCK) seems to decrease the likelihood of high discretionary accruals, especially those that increase earnings (coefficient of –3.406, significant at the 5% level). Finally, as suggested by the univariate results of Table 2, large firms are less likely to have high discretionary accruals, both income increasing and income decreasing, with coefficients around –0.3, significant at the 10% level. Overall, the results of Table 3 seem to indicate that there is a relationship between some aspects of corporate governance and the quality of a firm’s financial reporting. As one would expect, the characteristics of the audit committee are more directly associated with the level of earnings management than those of the board, whose influence on financial reporting is more diffuse. 6. Summary and conclusions Our study examines whether best practices proposed by quasi-regulators are related to the quality of financial reporting, as measured by the level of both positive and negative discretionary accruals. Results from logistic regression models suggest that these best practices and other characteristics are associated with less earnings management and support the call by the SEC for better governance practices. Specifically, the following audit committee characteristics are negatively associated with earnings management: the percentage of independent non-executive directors who are not managers in other firms, the presence of at least one member with financial expertise, the presence of a formal mandate establishing the committee’s responsibility for the oversight of both the financial statements and the external audit, and the prese...
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