The impact of independent directors and independent audit committees on earnings quality reported by Indonesian firms

Abstract

PurposeThe purpose of this paper is to investigate whether independent directors and audit committees that are chaired by an independent director as required by the Jakarta Stock Exchange (JSX) affect the quality of reported earnings.Design/methodology/approachThe paper uses both total discretionary accruals (DA) and earnings response coefficient (ERC) as the proxies for earnings quality. It runs multivariate regressions to examine the improvements in earnings quality after the firms meet the JSX requirements.FindingsIt is found that both DA and ERC improve significantly after firms acquire independent directors and independent audit committees. Lower DA occurs in the first and second years after the firms meet the JSX requirements. There is an improvement in ERC in the first years after firms meeting the requirements.Research limitations/implicationsThe results suggest that independent directors and audit committees do improve earnings quality.Originality/valueThis is the first paper that compares the quality of earnings before and after firms acquire independent directors and independent audit committees. This methodology allows us to examine the impact of meeting JSX independence requirements on earnings quality. The findings contribute to the literature by showing the importance of having independent directors and an independent audit committee in order to improve earnings quality. These findings are specifically important for the capital market regulatory bodies, the shareholders, and the boards of directors, and for other users of financial reports in general.