The Relation between Earnings Management Independent Directors and Audit Committee: A Study of Italian Listed Companies

Abstract

The study investigates whether and how earnings management depends on board monitoring, focusing, in particular, on two aspects: the role of independent directors and the presence of an audit committee in the Italian context. Empirical evidence about the topic does not come to unique results. In fact, on the one hand, independent directors and audit committees, being independent on management influence, are able to better protect shareholders from managerial opportunism (Fama and Jensen, 1983, Weisbach, 1988; Rosenstein and Wyatt, 1990; Byrd and Hickman, 1992; McWilliams and Sen, 1997), but, on the other hand, outside independent directors do not necessarily produce a better performance (Bhagat and Black, 1999; Klein, 1998; Agrawal and Knoeber, 1996) because the boards are “controlled” by management having better information than outside independent directors (Berle and Means 1932; Mace 1971).The purpose of the paper is providing an evidence about the impact of independent directors and audit committee on earnings management of Italian listed companies during the period 2002-2007. A regression analysis statistically examines this correlation. Our dependent variable is an earnings management metric based on the modified Jones model (Dechow, 1995). The results suggest that both independent directors and the existence of an audit committee mitigate earnings management. Governance and control variables are considered in terms of CEO powers and companies size and profitability.