Article2010

Does board governance improve the quality of accounting earnings?

Raghavan J. Iyengar · Judy K. Land · Ernest M. Zampelli

30 citations0/0 files storedAccounting Research Journal

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Auditing, Earnings Management, Governance Corporate Finance and Governance Corporate Governance and Financial Management

Abstract

Purpose The purpose of this paper is to examine the contention that a strengthening of corporate governance mechanisms would result in the improved relevance and reliability of financial statements. Design/methodology/approach Using pooled ordinary least squares regression, the paper analyse the quality of reported earnings for a sample of firms over the 1998‐2002 time period. Findings The findings show negative and statistically significant associations between reported earnings quality and the proportion of CEO incentive pay and firm's growth opportunities. It is also found that earnings quality is positively and significantly related to the existence of an orderly CEO transition process. However, board independence does not seem to be associated with earnings quality. Research limitations/implications Since the sample of firms is from the 1998 to 2002 period, consistent with the paper's motivation, the results may not generalize to the more recent time period. Practical implications The results provide support for the argument that the current structure of executive pay does adversely impact the quality of reported earnings and hence provides a rationale for closer scrutiny of executive pay by regulatory bodies. Additionally, the findings suggest that the emphasis on board independence as an effective monitoring device may be misplaced. Originality/value Unlike prior studies, the paper's hypotheses are derived from an explicit agency theoretic optimization model of managerial decision making. The paper uses the Ball and Shivakumar model for estimating abnormal accruals unlike previous analyses that relied more heavily on the Jones model. The paper also adds to past studies of the relationship between corporate governance and earnings quality and the role of executive compensation.

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References

1976Theory of the firm: Managerial behavior, agency costs and ownership structure 1983Separation of Ownership and Control 1997A Survey of Corporate Governance 1993The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems 1991Earnings Management During Import Relief Investigations 1996Higher market valuation of companies with a small board of directors 1995Detecting Earnings Management.1996Causes and Consequences of Earnings Manipulation: An Analysis of Firms Subject to Enforcement Actions by the SEC*

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