The investigation of the relationship between corporate governance and earnings quality

Abstract

This study investigates the relationship between earnings quality (accrual quality, earnings persistence, earnings predictability) and corporate governance dimensions (strength and adequacy) at listed companies in Tehran Stock Exchange. Under the premise that firms that have good performance in the past have less residual agency problem, we use return on equity (ROE) as a measure of the adequacy of corporate governance in place. We use constructed G-Index from corporate governance mechanisms as a measure of the strength of corporate governance. We find that earnings quality-accrual quality, earnings persistence, earnings predictability is higher for firms that have good performance 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. Further, we find that firms with weak-governance may not necessarily low earnings quality relative to firms with strong governance. We also find that as long as firms have adequate corporate governance, there is no different between weak-governance firms and strong-governance firms. Overall, the results support the conclusion of adequacy rather than the strength of corporate governance, which is associated with earnings quality. Key words: Strength of corporate governance, adequacy of corporate governance, accruals quality, earnings persistence, earnings predictability.