The effectiveness of corporate governance, institutional ownership, and audit quality as monitoring devices of earnings management

This study examines the effectiveness of different monitoring devices derived from some corporate governance factors, institutional ownership, and the quality of the audit process with their relation to earnings management behavior.; Using a sample of manufacturing companies during the years 1999 and 2000, the study applies different models suggested in the accounting literature to isolate discretionary accruals. The results support the expectations regarding the effect of the independent directors on the board, independence of the audit committee, institutional ownership, and the effect of the audit quality. The results are, however, inconsistent with the expectations that earnings management will increase with the CEO tenure and board size. The results show that the magnitude of discretionary accruals is negatively related to both of the CEO tenure and board size. The results also don't show any systematic relation between earnings management and the CEO duality. Tests of some interactions between the corporate governance variables indicate that the independence of the audit committee may be a function of the board size. The negative relation between earnings management and audit committee independence variable was significant only for big board observations (board size above the median). However, these interaction tests show no signs of interaction between the CEO duality and both of the CEO tenure or the board independence. The observed negative relation between earnings management and both of CEO tenure and board independence variables holds for both the CEO duality and non-duality observations. Interaction tests also indicate that the monitoring function of independent directors on the board is more effective when board independence is combined with higher institutional ownership, better audit quality, and bigger board size. Additional tests also examined the industry effect and the effect of loss avoidance incentive. The results of these tests show that the different monitoring devices examined in the study are less effective in the situations when managing earnings upward can reverse negative earnings to be slightly above zero. Tests on different industry segments show that the effect of these monitoring devices is generally similar in different industries. (Abstract shortened by UMI.)...