Effects of Corporate Governance and Board Equity Ownership on Earnings Quality

Abstract

There is evidence that insiders can overcome monitoring mechanisms and report low quality earnings, even in firms that meet the new legislative and exchange standards for governance. We show that earnings quality is directly affected by entrenched board members and that both independent and insider board members can become entrenched. We apply the Dechow and Dichev (2002) model of earnings quality to public corporations in the year 2002, and identify entrenchment thresholds associated with earnings quality. Although earnings quality is negatively correlated with insider ownership for entrenched firms, we also find that that the entrenchment effect can be moderated by governance structures. Our findings support a composite of governance factors creating a favorable governance environment as opposed to a single control (independent boards and/or audit committees).