Abstract
AbstractUsing conventional regressions and generalized regression neural networks (GRNNs), we examine the relationship between corporate governance (CG) and earnings management (EM). We also examine whether governance quality moderates the association between EM and CG for a sample of British and Egyptian companies. Our findings show that: (a) UK firms are likely to have lower levels of EM if they: have smaller boards, are dominated by independent outside directors, and have a low percentage of female directors; (b) Egyptian firms are likely to have lower levels of EM if they: have larger boards, are dominated by independent outside directors, and have a low percentage of female directors; (c) The governance quality (control of corruption) has a significant hidden effect on EM. Since our results provide empirical evidence that the board of directors plays a vital role in mitigating EM, these findings might lead to an improvement in the credibility of financial statements for investors in both the UK and Egypt. As policy implications, our findings inform regulators and policy‐makers that corruption has a very strong hidden effect on EM and that they can deter EM by controlling the corruption level in their countries.
Highlights
The aftermath of the considerable rise in earnings restatement and financial scandals, such as WorldCom, Enron, MG Rover Group, and Northern Rock, has raised investor concerns about corporate governance (CG)
Where earnings management (EM) refers to the absolute value of discretionary accruals as a proxy of EM for firm i during year t; CG refers to four corporate governance variables, namely independent outside directors (PIOD), board size (BSIZ), CEO duality (DUAL) and board females (BFEM); CGQ refers to governance quality, measured by control of corruption; CONTROLS refers to firm-level control variables, namely audit firm (AUDF), firm size (FSIZ), firm profitability (FPROF), firm capital structure (FCS), firm liquidity (FLIQ), firm growth (FGROW), and firm loss (FLOSS); δis the firm-year specific fixed-effects, and εis the white noise error term
Variables are defined as follows: independent outside directors (PIOD), independent outside directors multiplied by corruption (PIODCORR), board size (BSIZ), board size multiplied by corruption (BSIZZCORR); CEO duality (DUAL), CEO duality multiplied by corruption (DUALCORR), female ratio (BFEM), board female multiplied by corruption (BFEMCORR), corruption used as a proxy for governance quality (Corruption), audit firm size (AUDF), firm size (FSIZ), firm profitability (FPROF), firm capital structure (FCS), firm liquidity (FLIQ), firm growth (FGROW), firm loss (FLOSS)
Summary
The aftermath of the considerable rise in earnings restatement and financial scandals, such as WorldCom, Enron, MG Rover Group, and Northern Rock, has raised investor concerns about corporate governance (CG).
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