Chan, Bi Xuan
(2022)
The moderating effect of corporate governance on conditional conservatism and earnings management.
[Dissertation (University of Nottingham only)]
Abstract
Analytical literature presents ambiguous views on how conditional conservatism impacts earnings management. Despite being widely cited that conservatism limits accruals-based earnings management, this assumption is not well supported by empirical evidence. Also, no other study on this topic has been conducted in countries other than the US. Thus, with a UK sample of 1129 firm-year observations obtained from 2010-2018, this study tests the effects of conservatism on accruals-based and real earnings management, employing the Ordinary Least Square (OLS) approach. Results confirm that conservatism reduces accrual manipulation but simultaneously triggers a substitution of accrual management with real earnings management.
To enhance the benefits of conditional conservatism, the increase in real earnings management needs to be mitigated, possibly by corporate governance. Prior studies show mixed findings of how effective governance is in curbing earnings management. Hence, using the same sample and method, this study tests whether board characteristics mediate conservatism’s impact on earnings management. The results show that conservative firms with boards that are smaller, more active and more experienced are better at curbing accruals management, and importantly, less successful in triggering real earnings management. In contrast, boards that have more independent, non-executive and female directors have the opposite effect of amplifying increases in real earnings management and diminishing decreases in accrual management. This may be attributed to insufficient director expertise in lowering earnings management due to conservatism. Meanwhile, CEO-chairman separation reveals no mediating effect.
This study makes several contributions to the literature. First, it provides empirical evidence on the constraining effect of conditional conservatism on accrual management, as well as on the substitution of accruals-based manipulation with real earnings management. Second, it reports on whether conservatism influences earnings management differently in International Financial Reporting Standards (IFRS) and US Generally Accepted Accounting Principles (GAAP) environments. In turn, the generalisability of the findings to developed countries is improved. Third, it provides the first empirical evidence on the moderating effect of corporate governance on earnings management in conservative firms. Fourth, it offers firms a possible solution to reduce the unintended negative consequence of conservatism through board monitoring.
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