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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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This document was uploaded on 11/27/2013.
- Fall '13