Corporate governance mechanisms and accounting conservatism: evidence from Egypt

• DOI: https://doi.org/10.1108/CG-05-2017-0108
• Pages: 386-407
• Date: 07 February 2018
• Published date: 07 February 2018
• Author: Mahmoud A. Nasr,Collins G. Ntim
• Subject Matter: Corporate governance,Strategy

Corporate governance mechanisms and

accounting conservatism: evidence

from Egypt

Mahmoud A. Nasr and Collins G. Ntim

Abstract

Purpose – The purpose of this paper is to investigate the effect of corporate governance (CG)

mechanisms (board size, board independence, separation of chairman and chief executive officer (CEO)

roles and external auditor type) on accounting conservatism in Egypt.

Design/methodology/approach – Archival data relating to CG and accounting conservatism are

collected and analysed using multivariate regression techniques.

Findings – The findings indicate that board independence is positively associated with accounting

conservatism. By contrast, board size and auditor type are negatively associated with accounting

conservatism, while separating the chairperson and CEO roles has no significant relationship with

accounting conservatism.

Originality/value – To the best of the author’s knowledge, this is one of the first empirical attempts at

providing evidence on the relationship between CG and accounting conservatism in Egypt.

Keywords Egypt, Corporate governance, Accounting conservatism

Paper type Research paper

1. Introduction

This paper investigates the effect of corporate governance (CG) mechanisms on the extent

of accounting conservatism in Egypt. Separation between a firm’s principals (shareholders)

and managers (insiders) can result in managers having greater access to information

relating to its operations and management. Meanwhile the primary source of information for

shareholders is financial statements published by management. Shareholders are always

concerned with how managers implement the principles of accounting conservatism in their

financial estimates, as this often results in better protection for shareholders (Cullinan et al.,

2012). One reason for the increasing interest in accounting conservatism is that not all areas

of accounting are covered by accounting standards (Chung et al., 2003), with some areas

requiring a manager’s judgement, which could range from neutral or aggressive, and finally

to conservative behaviour and decisions. Therefore, the level of accounting conservatism

arguably depends on a manager’s estimates.

To control managers’ estimates and maintain conservative reporting, managers should be

monitored by instituting a number of CG mechanisms. For instance, the presence of a large

number of outsiders on the board can enhance the monitoring process, making managers

more conservative in their financial reporting (Garcı

´a Lara et al., 2007).

Several studies suggest that CG mechanisms can enhance the level of accounting

conservatism (Ahmed and Duellman, 2007; Ahmed and Henry, 2012; Elshandidy and

Hassanein, 2014; Kukah et al., 2016). Indeed, other studies have demonstrated that CG

Mahmoud A. Nasr is

Instructor at Faculty of

Commerce, Alexandria

University, Alexandria,

Egypt. Collins G. Ntim is a

Professor of Accounting

and Head of Department of

Accounting, Southampton

Business School, University

of Southampton, UK.

Received 31 May 2017

Revised 18 October 2017

Accepted 30 November 2017

PAGE 386 jCORPORATE GOVERNANCE jVOL. 18 NO. 3 2018, pp. 386-407, © Emerald Publishing Limited, ISSN 1472-0701 DOI 10.1108/CG-05-2017-0108

mechanisms, such as board size and board independence, can reduce accounting

conservatism (Chi et al., 2009; Lim, 2011). Meanwhile previous literature emphasises that

effective CG mechanisms restrict a manager’s opportunistic behaviour, and thus induce

them to be more conservative in their financial reporting. However, the link between CG

mechanisms and accounting conservatism varies across different institutional settings. For

instance – and using a sample of US firms – Garcı

´a Lara et al. (2009) note that there is a

positive association between CG mechanisms and the level of accounting conservatism.

Similarly, Lim (2011) evinces that CG attributes enhance the level of accounting

conservatism in Australian firms. This study, therefore, examines the effect of CG attributes

on the level of accounting conservatism in Egypt. As with the CG mechanisms examined in

previous literature, the common CG mechanisms that have been used in past studies

include board size, board independence, separation between the roles of chairman and

chief executive officer (CEO) positions, and auditor type.

Noticeably, the decision to focus on Egypt is motivated by a number of reasons. First, most

empirical evidence examining the association between CG and accounting conservatism

has been conducted in developed countries (Ahmed and Duellman, 2007; Garcı

´a Lara

et al., 2007; Cullinan et al., 2012) rather than in developing countries, such as Egypt. More

specifically, Egypt has a number of economic and market advantages, including:

n the most attractive market in terms of attracting foreign investment (EGX, 2011);

n one of the largest economies;

n one of the largest stock markets in terms of listed firms and market capitalisation;

n the most active and liquid stock market in terms of trading value and turnover; and

n is the largest country in the Middle East and North Africa (MENA) region in terms of

population.

Despite these economic developments, the CG practices are generally weak in Egypt,

urgently requiring improvement in terms of implementation provisions relating to disclosure.

Specifically, there is the need to enhance efficiency and transparency relating to financial

and non-financial reporting and disclosures, which are critical to the ability to attract foreign

direct investments (FDIs) in Egypt. Second, the late development of good CG practices and

reforms, including CG codes, reflects the weak legal systems prevalent in most developing

countries (Samaha et al., 2012). For example, the first formal Egyptian good CG code was

only introduced in 2005 and the latest in 2011 (Egypt Code of Corporate Governance, 2005/

2011). By contrast, such CG reforms began as early as in the late 1970s, early 1980s and

1990s in Hong Kong, the USA and the UK, respectively, for example.

Consequently, this paper seeks to contribute to the previous literature in three main ways.

First, to the best of our knowledge, it provides the first empirical evidence between CG

mechanisms and accounting conservatism in the MENA region. This extends existing

evidence to Egypt in particular, but the MENA region in general. Second, it suggests that in

weak CG and investor-protection countries like Egypt, accounting conservatism appears to

be a substitute for good governance. Third, it contributes to the literature by offering

policymakers and regulators in Egypt suggestions relating to how they may improve CG

practices in corporations.

The rest of the paper is structured as follows. Section 2 outlines CG reforms and financial

reporting challenges within the Egyptian context. Section 3 discusses CG and accounting

conservatism within Egypt. While Section 4 outlines the theoretical framework, Section 5

reviews the relevant literature and develops the hypotheses. Section 6 discusses the

research design and Section 7 presents the empirical analyses and findings. Section 8

describes results and discussion. Section 9 presents a brief summary, conclusion and

potential avenues for future research.

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