The Effect of Corporate Governance Mechanisms on Discretionary Accruals

Abstract: Purpose – The aim of this study is to empirically examine the relationship between corporate governance mechanisms in terms of ownership structure (institutional ownership, inside ownership, family ownership, CEO duality), board structure (board size, board independence, board meetings), audit committee structure (audit committee size, audit committee independence, audit committee meetings) and earnings management by publicly listed companies in Bangladesh. Design/methodology/approach – The non-discretionary accruals are measured using modified jones model with cross sectional basis from 392 firm-year observations. We employ multivariate model to investigate the relationship between discretionary accruals and various independent variables. Findings – The empirical results reveal that certain governance practices are important in limiting earnings management. In particular, institutional ownership, board size, and audit committee size, are associated with a significant decrease in earnings management among publicly listed companies. However, our results reveal that controlling shareholders in family business cannot have any effect on earnings management practices. Again, independent nonexecutive directors cannot effectively constrain opportunistic earnings management. The apparent reason for this phenomenon is attributed to the non-executive directors’ relative lack of knowledge in company’s affairs. Overall, the findings suggest that regulator bodies should adopt better governance structure by increasing the independence of outside directors on the board. Originality/value – This paper demonstrates the usefulness of corporate governance factors mainly institutional ownership, board ownership and effective audit committee on curbing earnings management practices. It contributes to existing literature by expanding the research to a sample of over a period of eight years. Implications: This research is based on recent data focusing on Bangladesh economy uniquely characterized largely by family-controlled firms. It is expected that this research will have important policy implications in enhancing the legitimacy of governance structures in emerging markets. Keywords: Corporate governance, Earnings management, Discretionary accruals (DACR), Agency theory, Bangladesh.