Earnings quality and internal control in bank-dominated corporate governance

Abstract

This study examines the relationship between internal governance and earnings management in Japanese listed firms. Following recent accounting fraud in large companies, Japanese internal governance systems have been widely criticized. Japan has a bank-dominated corporate governance system. This study predicts that the bank–client relationship mitigates opportunistic earnings management by reducing the degree of information asymmetry. The results show that bank-appointed audit board members mitigate managerial earnings management. Neither outside directors nor audit committees help reduce opportunistic managerial earnings management. The findings imply that a lender monitoring system can substitute the monitoring role of outside directors and audit committees.