Internal Governance and Real Earnings Management

71 Pages Posted: 16 Oct 2012 Last revised: 4 Oct 2014

Qiang Cheng

Singapore Management University

Jimmy Lee

Singapore Management University - School of Accountancy

Terry J. Shevlin

University of California-Irvine

Multiple version iconThere are 2 versions of this paper

Date Written: October 1, 2014

Abstract

We examine whether internal governance affects the extent of real earnings management in U.S. corporations. Internal governance refers to the process through which key subordinate executives provide checks and balances in the organization and affect corporate decisions. Using the number of years to retirement to capture key subordinate executives’ horizon incentives and using their compensation relative to CEO compensation to capture their influence within the firm, we find that the extent of real earnings management decreases with key subordinate executives’ horizon and influence. In cross-sectional analyses, we find that the effect of internal governance is stronger for firms with more complex operations where key subordinate executives’ contribution is higher, is enhanced when CEOs are less powerful, is weaker when the capital markets benefit of meeting or beating earnings benchmarks is higher, and is stronger in the post-SOX period, when real earnings management is likely more prevalent. The results are also robust to controlling for potential endogeneity concerns and to using alternative measures of internal governance that are used to rule out alternative explanations. This paper contributes to the literature by examining how internal governance affects the extent of real earnings management and by shedding light on how the members of the management team work together in shaping financial reporting quality.

Keywords: internal governance, real earnings management

JEL Classification: G32, M40

Suggested Citation

Cheng, Qiang and Lee, Jimmy and Shevlin, Terry J., Internal Governance and Real Earnings Management (October 1, 2014). Singapore Management University School of Accountancy Research Paper No. 5. Available at SSRN: https://ssrn.com/abstract=2162277 or http://dx.doi.org/10.2139/ssrn.2162277

Qiang Cheng (Contact Author)

Singapore Management University ( email )

60 Stamford Road
Singapore, 178900
Singapore

Jimmy Lee

Singapore Management University - School of Accountancy ( email )

60 Stamford Road
Singapore, 178900
Singapore
(65) 6808 5234 (Phone)

Terry J. Shevlin

University of California-Irvine ( email )

Paul Merage School of Business
Irvine, CA 92697-3125
United States
949-824-6149 (Phone)

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