Auditor Independence, Corporate Governance and Aggressive Financial Reporting: An Empirical Analysis

Journal of Management & Governance, May 2013, Volume 17, Issue 2, pp. 283-307

Posted: 31 Mar 2013

See all articles by Ahmed M. Abdel-Meguid

Ahmed M. Abdel-Meguid

The American University in Cairo - School of Business

Anwer S. Ahmed

Texas A&M University - Mays Business School

Scott Duellman

Saint Louis University - Department of Accounting

Abstract

This paper seeks to provide empirical evidence on the efficacy of three important governance mechanisms (auditors, directors, and institutional shareholders) in constraining aggressive financial reporting, proxied by abnormal accruals. It also examines the effects of the Sarbanes-Oxley Act (SOX) on their efficacy. Using a sample of US firms audited by the Big 5 (4) auditors between 2000 and 2004, we document a positive relation between abnormal accruals (our proxy for financial reporting aggressiveness) and auditors’ economic dependence on their clients. Furthermore, we find that this relation is driven by firms with weak non-auditor governance mechanisms before and after the enactment of SOX. The results suggest that aggressive financial reporting occurs only when multiple governance mechanisms ‘fail’. More specifically, such type of reporting requires that a highly dependent auditor operates in a ‘poor’ governance setting. Thus, the paper underscores the importance of strong governance in constraining aggressive financial reporting. Moreover, our results suggest that governance regulation (such as SOX) is not a substitute for strong governance mechanisms and thus caution against the over reliance on SOX-type legislation in other parts of the world.

Keywords: corporate governance, auditor independence, outside directors, institutional shareholders, aggressive financial reporting, The Sarbanes-Oxley Act (SOX)

JEL Classification: M41, G38

Suggested Citation

Abdel-Meguid, Ahmed M. and Ahmed, Anwer S. and Duellman, Scott, Auditor Independence, Corporate Governance and Aggressive Financial Reporting: An Empirical Analysis. Journal of Management & Governance, May 2013, Volume 17, Issue 2, pp. 283-307. Available at SSRN: https://ssrn.com/abstract=2241990

Ahmed M. Abdel-Meguid (Contact Author)

The American University in Cairo - School of Business ( email )

The American University in Cairo (AUC)
School of Business
New Cairo, 11835
Egypt

Anwer S. Ahmed

Texas A&M University - Mays Business School ( email )

430 Wehner
College Station, TX 77843-4353
United States

Scott Duellman

Saint Louis University - Department of Accounting ( email )

3674 Lindell Blvd.
St. Louis, MO 63108
United States

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