Corporate Governance and Earnings Management: A Meta‐Analysis

• Date: 01 September 2009
• DOI: http://doi.org/10.1111/j.1467-8683.2009.00753.x
• Published date: 01 September 2009
• Author: Juan P. Sánchez‐Ballesta,Emma García‐Meca

Corporate Governance and Earnings

Management: A Meta-Analysis

Emma García-Meca* and Juan P. Sánchez-Ballesta

ABSTRACT

Manuscript Type: Review

Research Question/Issue: The goal of this paper is to meta-analyze the results of 35 studies that examine the effect on

earnings management of f‌irms’ boards of directors and ownership structure.We examine whether differences in results are

attributable to moderating effects related to the system of corporate governance, the measurement of the governance

variable, or the particular specif‌ications of discretionary accruals models.

Research Findings/Insights: The f‌indings show that the variation in the results of previous studies on CEO duality and

audit committee independence are caused by sampling error. In addition, the measurement of dependent variable, discre-

tionary accruals, and the corporate governance system moderate the association between earnings management and some

corporate governance variables.

Theoretical/Academic Implications: The measurement of variables, especially discretionary accruals, inf‌luences the f‌ind-

ings found in previous studies. The f‌indings emphasize the need to explicitly consider the legal and institutional setting

when one analyzes the effect of mechanisms of corporate governance on discretionary accruals. Future research should

include matrix correlations, and consider detailed measures of earnings management and more attributes of boards of

directors in order to facilitate research using meta-analysis.

Practitioner/Policy Implications: The results suggest that board independence, board size, and audit committee indepen-

dence can improve investor conf‌idence by constraining earnings management. Additional empirical evidence regarding

ref‌ined measures of ownership and board, specif‌ically board independence, would be very useful in gaining greater

understanding of how the different approaches to these constructs inf‌luence earnings management.

Keywords: Corporate Governance, Audit Committee, Board of Directors, Ownership Issues, Ownership Structure,

Earnings Management, Agency Theory, Meta-Analysis

INTRODUCTION

The very nature of accounting accruals gives managers a

great deal of discretion in determining the earnings a

f‌irm reports in any given period because of information

asymmetry between managers and owners. Managers can

manipulate earnings in order to maximize their own inter-

ests or to signal their private information, thus inf‌luencing

the informativeness of earnings (Chung, Firth, & Kim, 2002;

Gul, Chen, & Tsui, 2003; Healy, 1985; Holthausen, Larcker, &

Sloan, 1995). Earnings management can be def‌ined as the

alteration of a f‌irms’ reported economic performance by

insiders either to mislead some stakeholders or to inf‌luence

contractual outcomes (Healey & Wahlen, 1999; Leuz, Nanda,

& Wysocki, 2003).corg_753594..610

Accounting earnings are more reliable and more informa-

tive when managers’ opportunistic behavior is controlled

through a variety of monitoring systems (Dechow, Sloan, &

Sweeney, 1996; Wild, 1996). After several recent f‌inancial

scandals, such as Enron, Xerox, or Worldcom, there has been

an international trend towards developing and implement-

ing corporate governance mechanisms to f‌ight against the

opportunistic behaviors that have undermined investors’

credibility in f‌inancial information. Corporate governance

attributes help investors by aligning the interests of manag-

ers with the interests of shareholders and by enhancing the

reliability of f‌inancial information and the integrity of the

f‌inancial reporting process (Watts & Zimmerman, 1986).

Although prior work has provided some insight into the

role of corporate governance, the results of similar studies

are frequently contradictory and there are several features

*Address for correspondence: Accounting and Finance Department, University of

Murcia, Campus de Espinardo 30100, Murcia, Spain. Tel:. +34-968367923; E-mail:

emmagar@um.es

594

Corporate Governance: An International Review, 2009, 17(5): 594–610

© 2009 Blackwell Publishing Ltd

doi:10.1111/j.1467-8683.2009.00753.x

of research that make it diff‌icult to draw substantive con-

clusions (Larcker, Richardson, & Tuna, 2007). To test the

validity and generalizability of the substantial research

undertaken in this f‌ield of research, it is necessary to

review, synthesize, and assess relevant empirical research.

Following Leonidou, Katsikeas, and Samiee (2002) such an

undertaking is important at this stage for three reasons.

First, most studies represent attempts aimed at investigat-

ing and testing only certain dimensions of corporate gov-

ernance. Second, investigation efforts take place at different

moments and in varying legal contexts, with a possible

exogenous effect on the f‌indings. Third, research designs,

such as the measurement of some variables, may be

diverse. The conf‌licting f‌indings of previous research limit

the theoretical and research development of this f‌ield.

Taking the above into account, we have identif‌ied 35 rel-

evant empirical studies that examine the relation between

earnings management and corporate governance. Our

objective in this paper is to integrate these results, achieve

a quantitative generalization, and f‌ind effects or relation-

ships that are not obvious from other ways of summarizing

research, such as narrative approaches. We will use the

meta-analysis technique, which is a quantitative review

methodology widely accepted in medical research and

other disciplines besides management. Where there are a

suff‌icient number of studies, most observers would be

more comfortable with conclusions drawn from a meta-

analytic review rather than narrative approaches, as meta-

analysis can account for sampling error and other statistical

artifacts in the data from the studies on which the analysis

relies (Hunter & Schmidt, 1990).

The benef‌its of the meta-analysis, the recent interest in

corporate governance,together with the social importance of

the credibility in f‌inancial information lead us to meta-

analyze the relation between corporate governance and

earnings management.

Following Denis and McConnell (2003), we classify cor-

porate governance mechanisms into two categories – boards

of directors and ownership structure – and we analyze the

effect on earnings management of several dimensions: (1)

Boards of directors: Board independence, board size, CEO

duality, and audit committee independence; and (2) Owner-

ship structure: Insider ownership, concentration, and insti-

tutional ownership. Meta-analysis will allow us f‌irst to

aggregate results across studies in order to obtain a robust

estimate of the relationship between each corporate gover-

nance variable and earnings management. The selection of

variables is based on the governance categories found in the

empirical research. Some mechanisms of corporate gover-

nance (e.g., CEO remuneration, family ownership) are not

analyzed because there are too few studies for meta-analysis

to be applied.

In addition, we also analyze whether differences in

studies are due to moderator effects such as the measure-

ment of discretionary accruals (type and sign of the model);

the approachused to def‌ine some corporate governance vari-

ables (ownership concentration and insider ownership); and

the system of corporate governance (Anglo-American, com-

munitarian, or emerging system).

Accordingly, this paper addresses several research ques-

tions. What is the overall effect of the different corporate

governance attributes on earnings management? Are inde-

pendent audit committees or blockholders more effective in

reducing earnings manipulation in Anglo-American coun-

tries in comparison to communitarian countries? Do the

results depend on the measurement of discretionary accru-

als? Are the f‌indings moderated by the measurement of the

governance variables?

The f‌indings show that in some mechanisms, such as

CEO duality and audit committee independence, the varia-

tions in results found in previous studies are due to

sampling error. The measurement of dependent variable,

discretionary accruals, is also a factor that explains differ-

ences in previous f‌indings. Specif‌ically, our results show

that board size and board independence only have a nega-

tive effect on earnings management with total accruals

models. This may suggest that f‌irms with larger and more

independent boards usually have fewer discretionary

accruals choices related to asset depreciation. This suggests

that when different discretionary accruals models are used,

results can change considerably, which conf‌irms that the

def‌inition of variables matters, especially with constructs

such as earnings management.

The results do not support most corporate practice recom-

mendations that strongly suggest the positions of board

chairman and CEO be held by different individuals. Yet we

do see that abnormal accruals are less pronounced in f‌irms

with independent audit committees.

In addition, we f‌ind signif‌icant differences between

corporate governance systems with regard to the role of

independent directors, a mechanism that does not appear

to be eff‌icient in constraining earnings management prac-

tices in communitarian and emerging countries. The

greater presence there of controlling shareholders and less

of a board tradition of defence against managers would

explain these results. Nevertheless, we are concerned

about the measure of board independence, overall in com-

munitarian studies, where there are many fears that board

members are not independent of those who nominate

them.

We attempt to shed additional light for regulators, such as

the Organization for Economic and Corporate Development

Council or the Commission of the European Communities,

which are engaged in the formulation of guidelines for

improved corporate governance. The results suggest that

codes of good governance should explicitly consider the

institutional framework of a country, because the implemen-

tation of some good practices from other countries without

considering the origin of a country’s legal institution could

be ineffective. The f‌indings also support regulators’attempts

in communitarian and emerging countries to improve the

independence of corporate boards.

The rest of the paper is as follows: in the second section,

we discuss the literature about corporate governance and

earnings management; then, we examine the possible mod-

erators for the relationships analyzed. In the methodology

section we present the meta-analytic technique used and

the description of sample and variables. In the results

section we show the results of the meta-analyses for each

corporate governance variable, and we end with a discus-

sion of results in a summary, discussion, and further

research section.

CORPORATE GOVERNANCE AND EARNINGS MANAGEMENT 595

Volume 17 Number 5 September 2009© 2009 Blackwell Publishing Ltd