The Predictive Power of K-Nearest Neighbor (KNN): The Effect of Corporate Governance Mechanisms on Earnings Management

Mengyun Wu,Jonas Bawuah,Martha Coleman

doi:10.1177/2158244020949537

Abstract

This study investigates the long-run effect of corporate governance mechanisms on earnings management of listed companies in Nigeria and Ghana. The study uses Ant Colony Optimization (ACO) and K-Nearest Neighbor (KNN) in establishing a long-run effect of good corporate mechanisms in reducing earnings management practice by corporate managers. ACO selected four major corporate governance mechanisms: Board Procedure Index, Board Disclosure Index, Ownership Structure Index, and Shareholders’ Rights Index; these were the key corporate governance mechanisms that influence the reduction in earnings management activities. KNN produced a strong significant longitudinal effect of implementing good corporate governance mechanisms in decreasing the manipulating behavior of managers. Quality corporate governance mechanisms’ implementation reduces the opportunistic behavior of corporate managers in manipulating earnings. Therefore, the study alert policymakers the urgency in setting up appropriate policies to enhance the reduction in earnings management practices to provide accurate financial information for stakeholders’ financial decision-making. The use of ACO and KNN in the study is a great novelty, which presents a calibration and prediction of the impact of corporate governance mechanisms on earnings management showing the rate of reduction.

Highlights

The implementation of Sarbanes-Oxly (SOX) Act of 2002 in the United States has led to other countries to realize the significance of quality corporate governance mechanisms implementation in lowering agency cost and maximizing shareholders’ wealth
The maximum and minimum values of control variables were GRTH ranges from 3.25 to 9.18 (6.66), CAPEX ranges from 0.00013 to 1.69 (0.42), FAGE ranges from I to 51 (23.3), MAEFF ranges from 0 to 2.4 (1.0), CFO ranges from −0.72 to 0.88 (0.09), SIZE ranges from 3.6 to 9.2 (6.7), and LEV ranges from −0.47 to 6.977 (0.66); this shows that more than 50% of the firms are highly leverage, which indicates that African countries rely heavily on debt in financing their business operation
This study looked at the influence of corporate governance mechanisms with other control variables on accrual-based and real transaction earnings management of firms listed in Nigeria and Ghana

Summary

Introduction

The implementation of Sarbanes-Oxly (SOX) Act of 2002 in the United States has led to other countries to realize the significance of quality corporate governance mechanisms implementation in lowering agency cost and maximizing shareholders’ wealth. This realization has ignited several studies in emerging economies to investigate the impact of corporate governance on firm value (Sajid & Afza, 2018). The African continent has come a long way of institutionalizing corporate governance in organizations through economic globalization for better resource utilization and goal achievement. For every investor to channel resources into any developing economy, there should be well-established corporate governance mechanisms and sound firm performance.

Methods

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Discussion

Conclusion