The Impact of Board Internationalization on Real Earnings Management: Evidence From China

Badar Nadeem Ashraf,Ningyu Qian

doi:10.1177/21582440211032640

Abstract

In this article, we examine the impact of board internationalization on real earnings management. Using the annual data of 2,899 Chinese listed non-financial firms with 16,638 firm-year observations over the period from 2008 to 2017 for empirical analysis, we find robust evidence that higher proportion of foreign directors on corporate boards reduces real earnings management. Results support the hypothesis that foreign directors increase boards’ effectiveness in monitoring the management and, consequently, lead to less earnings management by corporate executives. Our results are robust to alternative measures of board internationalization, instrumental variable analysis, and adding additional control variables. We further observe that foreign directors are more effective in reducing earnings management in firms with local directors with foreign experience and in Chinese provinces with developed institutional environment. Moreover, Chinese firms complement accrual and real activities–based earnings management, and board internationalization is effective in reducing both types of earnings management. Overall, our findings imply board internationalization improves the quality of reported earnings to outside shareholders.

Highlights

Large corporate frauds, such as the Enron and Worldcom scandals, incorporating the fraudulent financial reporting have led to recognize the importance of corporate governance for financial reporting of firms
IV represents the main independent variable of interest which is the ratio of foreign directors at corporate boards
This study examines the impact of board internationalization on real earnings management by corporate executives

Summary

Introduction

Large corporate frauds, such as the Enron and Worldcom scandals, incorporating the fraudulent financial reporting have led to recognize the importance of corporate governance for financial reporting of firms. The appointment of independent (Klein, 2002), female (Adams & Ferreira, 2009; Harakeh et al, 2019; Srinidhi et al, 2011), or experienced and more educated directors (Makaryanawati et al, 2016; Reeb & Zhao, 2013) at corporate boards can improve accounting disclosures quality and reduce earnings management. Another recent and noteworthy addition to this debate is whether and how the board internationalization affects the earnings management practices of firms. Foreign directors can increase the board’s effectiveness in monitoring the management because of the reasons that they import foreign corporate governance experience, better understand international capital markets, and are more independent of the management and can critically scrutinize the managers for earnings management (Estélyi & Nisar, 2016; Miletkov et al, 2017; Oxelheim et al, 2013; Oxelheim & Randøy, 2003)

Results

Discussion

Conclusion