Corporate Governance and Earnings Management

35 Pages Posted: 29 Jun 2001  

Sonda Marrakchi Chtourou

University of Sfax

Jean Bédard

Université Laval - École de comptabilité

Lucie Courteau

Free University of Bozen-Bolzano - Faculty of Economics and Management

Date Written: April 21, 2001

Abstract

This study investigates whether a firm's corporate governance practices have an effect on the quality of its publicly released financial information. In particular, we examine the relationship between audit committee and board of directors characteristics and the extent of corporate earnings management as measured by the level of positive and negative discretionary accruals. Using two groups of US firms, one with relatively high and one with relatively low levels of discretionary accruals in the year 1996, we find that earnings management is significantly associated with some of the governance practices by audit committees and boards of directors. For audit committees, income increasing earnings management is negatively associated with a larger proportion of outside members who are not managers in other firms, a clear mandate for overseeing both the financial statements and the external audit, and a committee composed only of independent directors that meets more than twice a year. We also find that short-term stocks options held by non-executive committee members are associated with income increasing earnings management. Income decreasing earnings management is negatively associated with the presence of at least a member with financial expertise and a clear mandate for overseeing both the financial statements and the external audit.

For the board of directors, we find less income increasing earnings management in firms whose outside board members have experience as board members with the firm and with other firms. We also find that larger board, the importance of the ownership stakes in the firm held by non-executive directors, and experience as board members seems to reduce income decreasing earnings management.

Our results provide evidence that effective boards and audit committees constrain earnings management activities. These findings have implications for regulators, such as the Securities and Exchange Commission (SEC), as they attempt to supervise firms whose financial reporting is in the gray area between legitimacy and outright fraud and where earnings statements reflect the desires of management rather than the underlying financial performance of the company, as pointed out by the Blue Ribbon Committee (1999).

Keywords: Corporate governance; Audit committee; Earnings management; Discretionary accruals

JEL Classification: M41, M43, G34, J33, K22

Suggested Citation

Marrakchi Chtourou, Sonda and Bédard, Jean and Courteau, Lucie, Corporate Governance and Earnings Management (April 21, 2001). Available at SSRN: https://ssrn.com/abstract=275053 or http://dx.doi.org/10.2139/ssrn.275053

Sonda Marrakchi Chtourou

University of Sfax ( email )

Faculte des Sciences Economiques et de Gestion de Sfax
Sfax
Tunisia

Jean Bédard (Contact Author)

Université Laval - École de comptabilité ( email )

2325, rue de la Terrasse
Québec, Quebec G1K 7P4 G1V 0A6
Canada
418-656-7055 (Phone)
418-656-2624 (Fax)

Lucie Courteau

Free University of Bozen-Bolzano - Faculty of Economics and Management ( email )

Faculty of Economics and Management
Piazza Università 1
39100 Bozen-Bolzano (BZ), Bozen 39100
Italy

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