Outside Directors, Board Effectiveness, and Earnings Management

33 Pages Posted: 16 Sep 1998

See all articles by Peter F. Pope

Peter F. Pope

Bocconi University; London School of Economics and Political Science

Ken V. Peasnell

Lancaster University - Department of Accounting and Finance

Steven Young

Lancaster University - Department of Accounting and Finance

Date Written: April 1998

Abstract

Corporate law defines an explicit responsibility for boards of directors in the financial reporting process. In so doing it raises the expectation that boards will constrain earnings management activity. This paper tests for evidence of an empirical association between the composition of the board of directors and earnings management. The nature and extent of earnings management is proxied by discretionary accruals, estimated using a cross-sectional version of the Jones (1991) model. Using a sample of 1178 firm-year observations for U.K. non-financial firms over the period 1993-1996, we report evidence of a significant negative association between income-increasing accruals and the proportion of outside board members. These findings persist after controlling for possible interactions between different governance mechanisms and for the endogeneity of board composition. Our results provide the first large-sample evidence that effective boards constrain earnings management activity.

JEL Classification: M41, G34, D23

Suggested Citation

Pope, Peter F. and Peasnell, Kenneth V. and Young, Steven, Outside Directors, Board Effectiveness, and Earnings Management (April 1998). Available at SSRN: https://ssrn.com/abstract=125348 or http://dx.doi.org/10.2139/ssrn.125348

Peter F. Pope

Bocconi University ( email )

Dept of Accounting
Milan, 20136
Italy

London School of Economics and Political Science ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Kenneth V. Peasnell

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+44 1524 593631 (Phone)
+44 1524 847321 (Fax)

Steven Young (Contact Author)

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster LA1 4YX
United Kingdom
+441 5245-94242 (Phone)
+441 5248-47321 (Fax)

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