On the Association Between Corporate Governance and Earnings Quality

Abstract

This study investigates whether accrual quality, earnings persistence and earnings predictive ability are affected by the adequacy rather than the strength of corporate governance. Under the premise that firms that have consistently outperformed their industry counterparts in the past have less residual agency problem, we use past industry-adjusted performance as a measure of the adequacy of corporate governance in place. We use Gompers’ index as a measure of the strength of corporate governance. We find that reporting/earnings quality - accrual quality, earnings persistence, and earnings predictability - is higher for firms that have consistently outperformed their industry counterparts in the past regardless of whether the corporate governance levels were strong or weak. We also find that reporting/earnings quality is higher for such firms after controlling for the strength of corporate governance.