Earnings Management and Corporate Governance in Asia's Emerging Markets

Abstract

This paper studies the impacts of corporate governance on earnings management. We use firm‐level governance data, taken from Credit Lyonnais Security Asia (CLSA), of nine Asian countries, in addition to the country‐level governance data used in past studies. Our conclusion is as follows. First, firms with good corporate governance tend to conduct less earnings management. Second, there is a size effect for earnings smoothing, that is, large size firms are prone to conduct earnings smoothing, but good corporate governance can mitigate the effect on average. Third, there is a turning point for leverage effect, i.e. when the governance index is large, leverage effect exists, otherwise reverse leverage effect exists. It shows that a highly leveraged firm with poor governance is prone to be scrutinised closely and thus finds it harder to fool the market by manipulating earnings. Fourth, firms with higher growth (lower earnings yield) are prone to engage in earnings smoothing and earnings aggressiveness, but good corporate governance can mitigate the effect. Finally, firms in stronger anti‐director rights countries tend to exhibit stronger earnings smoothing. This counter‐intuitive result is different from Leuz et al. (2003).