Abstract
Although US and European research has documented improvement in earnings quality associated with corporate governance characteristics, the situation in Latin America is questionable, given the business environment in which firms operate, which is characterized by controlling family ownership and weak legal protection. The purpose of this study is to examine the relation between the internal mechanisms of Corporate Governance and Earnings Management measured by discretionary accrual. We use a sample of listed Latin American non-financial companies from the period 2006–2009. Our results show how in the Latin American context the role of external directors is limited and that Boards which meet more frequently take a more active position in the monitoring of insiders, so showing a lower use of manipulative practices. In addition, we find a non-linear relation between insider ownership and discretionary accruals, also pointing to the fact that ownership concentration may be a manipulative practices constrictor mechanism only when the ownership of main shareholders is moderate. The findings have important policy implications since this is, to the best of our knowledge, the first study to analyze the relation between the effectiveness of the government and the earnings management behavior. As policy implications, we document how when a country implements controls aimed at reducing corruption, strengthening the rule of law or improving the effectiveness of government, this leads to a reduction in firm earnings management.
Highlights
In recent years large accounting fraud uncovered in the stock markets has once again confirmed the existence of ethical failures and the importance of transparency and reliability of the financial information provided to markets (Lang and Lundholm 2000)
According to the approaches set out, this paper’s main objective is to analyze the relation between the internal mechanisms of CG and EM in firms listed on the main Latin American stock markets, on the markets of Argentina, Brazil, Chile, and Mexico, during the period 2006–2009
Our result is in line with those obtained by Machuga and Teitel (2009) with a sample of Mexican firms, who show that firms with less internal ownership show a greater earnings quality compared to those that do not have managerial ownership, i.e., shows less manipulative practices by managers, because of the implementation of good CG practices contained in Codes of Best Practices
Summary
In recent years large accounting fraud uncovered in the stock markets has once again confirmed the existence of ethical failures and the importance of transparency and reliability of the financial information provided to markets (Lang and Lundholm 2000). A weak governance structure may provide an opportunity for managers to engage in behavior that would eventually result in a lower quality of reported earnings, which is a strong indication of a serious decay in business ethics. Since the studies published by Jensen and Meckling (1976) and Fama and Jensen (1983), it has been assumed that both, the role of the board of directors and ownership structure, are crucial in monitoring managerial activity, as they are capable of reducing agency costs resulting from the alignment of ownership and management interests.
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