Corporate Governance and Earnings Management: A Case of Karachi Stock Exchange Listed Companies

Abstract

The prime aim of this study is to investigate the impact of corporate governance practices on earnings management. We employed fixed effect estimators on a sample of 89 non-financial companies listed on KSE (Karachi Stock Exchange), for the period 2003–2012. Corporate governance has been quantified through its four different practices (namely, board size, managerial ownership, CEO–chair duality, and audit committee independence) whereas discretionary accruals have been used as a proxy for measuring earnings management and are calculated through modified Jones model developed by Dechow, Sloan and Sweeney (1995). The empirical findings are quite in line with the philosophy of corporate governance. Audit committee independence and earnings management are negatively correlated. Similarly, CEO–chair duality is positively associated with earnings management. However, two of the corporate governance variables (i.e., board size and managerial ownership) are found insignificantly related to earnings management. The study contributes in general to the existing literature on corporate governance and earnings management by examining their relationship; that corporate governance is negatively associated with earnings management. The study contributes specifically by evidencing that in developing countries like Pakistan, where the interest war is more prominent among the minority shareholder and controlling shareholders than among management and owners, corporate governance is playing an effective role to overcome these problems.