The Effect of Shareholder-Initiated Corporate Governance on Accrual-Based and Real Earnings Management

52 Pages Posted: 14 Jul 2017 Last revised: 29 Jan 2018

See all articles by Jeffrey Ng

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance

Hong Wu

Fudan University - School of Economics

Jing Zhao

Hong Kong Polytechnic University - School of Accounting and Finance

Weihuan Zhai

Hong Kong Polytechnic University - School of Accounting and Finance

Date Written: July 14, 2017

Abstract

Shareholder activism is an important source of corporate governance. Using a dynamic regression discontinuity design on shareholder proposals that pass or fail by a small margin of votes in shareholder meetings, we analyze the effect of shareholder-initiated corporate governance on earnings management. We find that both accrual-based and real earnings management diminish after shareholder proposals are passed. However, when we focus on proposals to improve auditor independence or to approve clawback provisions (i.e., proposals targeted at firms’ financial reporting), we find that accrual-based earnings management decreases while real earnings management increases, suggesting a substitution effect. Consistent with one of these proposals’ objectives, dealing with weakness in financial reporting due to “entrenched” auditors, we find that the substitution effect is stronger for firms with entrenched auditors. The substitution effect is also stronger when a firm has less analyst coverage and lower institutional investor ownership, suggesting a shift to potentially more costly real earnings management when there is weaker external monitoring. Overall, our paper contributes to the literature on shareholder activism by demonstrating that shareholder-initiated corporate governance can affect earnings management and that the effect can vary depending on the nature of the activism.

Keywords: shareholder activism, shareholder proposals, accrual-based earnings management, real activities manipulation

Suggested Citation

Ng, Jeffrey and Wu, Hong and Zhao, Jing and Zhai, Weihuan, The Effect of Shareholder-Initiated Corporate Governance on Accrual-Based and Real Earnings Management (July 14, 2017). Asian Finance Association (AsianFA) 2018 Conference, Available at SSRN: https://ssrn.com/abstract=3002464 or http://dx.doi.org/10.2139/ssrn.3002464

Jeffrey Ng

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Hong Wu (Contact Author)

Fudan University - School of Economics ( email )

600 GuoQuan Road
Shanghai, 200433
China

Jing Zhao

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

Weihuan Zhai

Hong Kong Polytechnic University - School of Accounting and Finance ( email )

Hung Hom
Kowloon
Hong Kong

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