Independent Director Interlocks,Internal Control And Earnings Quality

The report to the 19th National Congress of the Communist Party of China clearly pointed out that China's economy has shifted from a high-speed growth stage to a high-quality development stage.Since internal control serves as the micro-foundation that firms pursue for high-quality development,much attention has been given to how to improve the quality of internal control scientifically and reasonably.Corporate governance is one of the important factors affecting internal control,while independent directors,as a vital part of corporate governance,exercise the right of supervision,thereby called the "gatekeepers" of listed companies' compliance operations and real information disclosure.However,the independent director system as an imported product finds itself in an unaccustomed climate after introduction into the supervision system of listed companies in China.In the circle of practice,independent directors are often considered "not independent" and "derelict",working as nothing but a "flower vase".Are all independent directors playing an equal role?Are there other factors that determine the value of independent directors?These are called the "mystery of the role of independent directors",which has stimulated the interests in exploring the value of independent directors.Early research on the role of independent directors in China and abroad was generally focusing on proportion of independent directors or their personal characteristics like professional background.However,with the evolution of the capital market supervision system,proportion of independent directors and their professional background in listed companies have shown an increasingly assimilation tendency,which makes the research results contradictory.The proposing of the "weak T" theory provides new ideas for studying the governance role of independent directors,which helps researchers jump out of the stereotype of making research just from the perspectives of proportion of independent directors or professional background.According to the statistics of China Research Data Service Platform(Cnrds)and CSMAR,the number of the A-share companies with independent director interlocks in 2017 was 950,accounting for 27.42%of the total A-share companies.In 2015-2017,the total number of companies with independent director interlocks was 3,159,accounting for 33.96%in average.Therefore,this research aims to study the role of independent director interlocks in internal control,and further explore the role of independent director interlocks and internal control in uplifting earnings quality.The contribution of this paper lies in:(?)answering the "questions left over from history".For example,this paper provides a new perspective for the "unsolved mysteries" in the research by Nguyen and Nielsen(2010)(e.g.,whether or not independent directors have the same value).(?)By comparing the governance effectiveness of independent director interlocks and internal control,this paper clarifies the roles of external independent director interlocks mechanism and internal control in specific earnings decision-making activities,thereby alleviating the debate about the costs and benefits of internal control.(?)filling the gaps in the existing literature on the economic consequences of independent director interlocks,the influencing factors of internal control,and the governance mechanism of earnings quality;and In addition,the findings of this paper can help regulators and practitioners understand how to respond positively to the requirements of the 19th National Congress of the Communist Party of China for high-quality development,and deepen their understanding of the choice of earnings management methods and the governance mechanism of earnings management and persistence,which thereby can perfect the directions and methods of supervision over earnings quality.Taking independent director interlocks as the research perspective,this paper thoroughly explores the relationship among independent director interlocks,internal control,and earnings quality.This research comes to the following three conclusions.(?)Based on reputation effect,independent director interlocks can significantly improve companies' internal control quality,and the interlocks of independent directors who concurrently hold a post in several companies has a more obvious impact on internal control quality.Based on learning effect,interlocks of independent directors,especially those with high education background,can remarkably improve the attendance rate of directors.In addition,this paper clarifies the transmission mechanism of the impact of independent director interlocks on internal control quality,i.e.,increasing the attendance rate of directors and thus uplifting internal control quality.(?)There is a clear substitution relationship between internal control and independent director interlocks,which both can significantly restrain companies' accrual earnings management behaviors.Only internal control can observably inhibit the real earnings management behaviors of companies,while independent director interlocks can't contribute to the inhibition;meanwhile,in this scenario,there is no significant substitution relationship between them.Internal control exerts a remarkable inhibitory effect on the upward and downward accrual earnings management,while independent director interlocks mainly find their role in the upward accrual earnings management.Internal control has a significant inhibitory effect on production costs,operating cash flow and discretionary expense manipulation,while independent director interlocks have a certain governance effect on production cost manipulation,albeit with no obvious effect on the overall real earnings management.Compared with internal control that has a more comprehensive and stable inhibition effect on earnings management,independent director interlocks are more susceptible to corporate strategy in terms of governance effect.(?)Independent director interlocks can significantly improve earnings persistence,and there is a certain substitution relationship between independent director interlocks and internal control in enhancing the persistence.Independent director interlocks contribute to the correct pricing of accrual earnings and cash flow earnings,and helps alleviate the accrual abnormalities of listed companies.Noteworthily,independent director interlocks are still susceptible to the governance willingness of companies,and only when the overall strategy of a company is relatively stable can independent director interlocks enhance earnings persistence.