The impact of ownership type on the relationship between corporate governance and earnings management: An empirical study

Ahmed Boghdady

doi:10.22495/cocv16i4art3

Abstract

This study investigates the effect of ownership type on the relation between corporate governance and earnings management. While previous literature has mainly examined the relationship between corporate governance and both accrual and real earnings management, no study to date, to the researcher’s best knowledge, focused on the moderation effect of ownership type on this relationship. Three proxies for measuring accrual and real earnings management, namely discretionary accruals (DA), abnormal cash flows (ACFO), and abnormal discretionary expenses (ADISX) are employed. Three empirical models (i.e. DA, ACFO, and ADISX) are developed in which the earnings management proxies represent the dependent variables and are tested using a sample of non-financial companies containing state-owned and privately owned companies over the period from 2010 to 2017, with 1030 firm-year observations. The results show a positive relationship between ownership type and both accruals manipulation and sales manipulation. In general, the results suggest that the ownership type moderates the relationship between corporate governance and earnings management. The results suggest also that corporate governance mechanisms may not play an almost the same role in monitoring and mitigating real earnings management (REM) practices as they do for accrual earnings management (AEM) in Egypt. Moreover, no evidence is found supportive of the trade-off effect which means that managers in Egyptian firms use both types of earnings management jointly to reach the target levels of earnings

Highlights

Agency theory predicts that firms that are suffering from pronounced agency conflicts are engaged in opportunistic practices (Jensen & Meckling, 1976)
This study examines the effect of ownership type to differentiate between the nature of this relationship in state-owned companies (SOEs) compared with privately-owned companies (POEs)
The results show only independent board members are influential in constraining real activities earnings management (REM), while the other characteristics of the board and the audit committee that have been found to be significant in limiting accrual-based earnings management (AEM) have no effect in limiting REM, because most members may primarily focus upon accrual-type earnings management

Summary

Introduction

Agency theory predicts that firms that are suffering from pronounced agency conflicts are engaged in opportunistic practices (Jensen & Meckling, 1976). Previous literature proposes that ownership structure and corporate governance mechanisms can successfully align the interests of managers with those of the stockholders and effectively monitor the opportunistic behavior of management (Fama & Jensen, 1983; Shleifer & Vishny, 1997). These predictions are examined in developed markets (Klein, 2002; Xie et al, 2003; Davidson et al, 2005; Peasnell et al, 2005). This study, examines these issues and validates the agency theory predictions regarding the effectiveness of corporate governance mechanisms in mitigating both types of earnings management (i.e. AEM and REM) in Egypt. The problem of this study can be summarized as follows: Does ownership type moderate the relationship between corporate governance mechanisms and both types of earnings management?

Methods

Results

Conclusion