Board Independence and Real Earnings Management: The Case of R&D Expenditure

Abstract

The evidence supports the emphasis that recent policy statements have put on increasing the number of independent directors on corporate boards. This study offers insights to policy makers interested in enhancing the monitoring role of corporate boards. The results indicate that independent directors have sufficient technical knowledge to identify opportunistic reductions in R&D, and efficiently constrain opportunistic R&D spending. Using a large sample of UK firms, I study whether independent boards are efficient at detecting and constraining myopic R&D cuts. The results indicate that more independent boards constrain the manipulation of R&D expenditure. The research design controls for the potential confounding effect of the decision to capitalize vs. expense R&D outlays. This paper analyzes the role of boards of directors in constraining research and development (R&D) spending manipulation. Extant research on earnings management indicates that independent directors reduce accounting accruals manipulation; however, there is little evidence on their effectiveness in limiting potentially value reducing R&D cuts motivated by short-term earnings pressures. This paper analyzes the role of boards of directors in constraining research and development (R&D) spending manipulation. Extant research on earnings management indicates that independent directors reduce accounting accruals manipulation; however, there is little evidence on their effectiveness in limiting potentially value reducing R&D cuts motivated by short-term earnings pressures. Using a large sample of UK firms, I study whether independent boards are efficient at detecting and constraining myopic R&D cuts. The results indicate that more independent boards constrain the manipulation of R&D expenditure. The research design controls for the potential confounding effect of the decision to capitalize vs. expense R&D outlays. The results indicate that independent directors have sufficient technical knowledge to identify opportunistic reductions in R&D, and efficiently constrain opportunistic R&D spending. The evidence supports the emphasis that recent policy statements have put on increasing the number of independent directors on corporate boards. This study offers insights to policy makers interested in enhancing the monitoring role of corporate boards.