Discretionary charges, board of director composition, and audit quality

Recently, regulators, interest groups, and the popular press have asserted that managers record excessive restructuring charges and write-downs to manage earnings. They suggest that improved audit committee oversight and higher quality audits would mitigate these "abuses." To test these assertions, I develop a model that isolates the discretionary portion of large asset write-downs and restructuring charges.; Analyses suggest that managers use discretionary charges to smooth income when current-period earnings are high, and to take an "earnings bath" when current-period earnings are low. Managers are more likely to record discretionary charges when top management turnover occurs. They are more (less) likely to record discretionary charges when compensation plans state that awards will be (not be) tied to performance measures that are easily manipulated by the recognition of discretionary charges. They are less likely to record discretionary charges when their incentive compensation awards are based on other measures. Further, the magnitude of discretionary charges is smaller (larger) when bonus awards are based on non-financial (financial) performance measures.; I find some associations between director shareholdings and discretionary charges, and between a measure of CEO power and discretionary charges, but I find no association between the charges and the proportion of directors that are outsiders or between the charges and measures of auditor quality.; My evidence suggests that audit committee characteristics influence the quality of financial reporting. Managers of firms with audit committees comprised of at least three members, firms with audit committees that contain at least one member with accounting or related financial expertise, and firms where outside audit committee members serve on fewer other boards, record smaller discretionary charges. This suggests that sufficient time, financial sophistication, and effort are required for audit committee members to be effective monitors.; Overall, my results suggest that some traditional governance mechanisms are not effective in light of income-decreasing earnings management and lend support to some suggestions made by the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees.