Abstract
The purpose of this study is to examine the impact of social relations among the board members on earnings management in Pakistani listed companies. Specifically, we have analyzed the social networks between CEO and outside board members. The modified Jones model has been used in this study to measure earnings management and we have captured social relations through SOCIAL (Social networking index). Our results suggest that firms with more connected boards show a positive relationship between board independence and earnings management. Further, we have shown that firms with CEO duality exhibit a higher association between social connections of the board and earnings management than firms with non-duality. Social relations among the board members undermine monitoring ability of outside directors and the impact becomes more severe in the presence of CEO duality.
Highlights
In this study, we have analyzed the effect of social relations between outside directors and Chief Executive Officer (CEO) on earnings manipulation
Findings of the study are in line with prior research that social relations with CEO undermine the monitoring ability of outside director (Dey and Liu 2010; Fracassi and Tate 2012) and increase the earnings management activities (Hwang and Kim 2010; Krishnan et al 2011)
Our results suggest that the director, who has a social affiliation with the CEO, might work on the board as an outside director but may not improve the monitoring mechanism
Summary
We have analyzed the effect of social relations between outside directors and CEO on earnings manipulation. CEO with board members did not catch the attention of previous researchers and regulators have not developed formal guidelines in this regard such as a “code of corporate governance” (Hwang and Kim 2010) These social relations can influence the transparency of accounting records and undermine the monitoring of independent directors. Leuz et al (2003) clustered the countries according to their institutional settings in the study, where Pakistan was ranked in the third cluster (insider economies) These settings and characteristics of Pakistan provide an ideal environment to conduct a study on board monitoring mechanisms and earnings management in the context of social-ties between a CEO and outside directors. We have explained the results and have drawn conclusions
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