[Earnings Management and Corporate Governance]

by

DECLARATION

I, [type your full first names and surname here], declare that the contents of this dissertation/thesis represent my own unaided work, and that the dissertation/thesis has not previously been submitted for academic examination towards any qualification. Furthermore, it represents my own opinions and not necessarily those of the University.

Signed __________________ Date _________________

Abstract

This study investigates whether corporate governance characteristics, mandated by the UK Generally Accepted Accounting Principles (GAAP) for companies listed in United Kingdom, are associated with earnings management. In particular, we examine whether the independence, economic recession, and voluntary formation of independent directorships (supervisorships) are associated with the absolute value of discretionary accruals. Our findings suggest that the independence of supervisors, the economic recession of independent directors, and the voluntary formation of independent directorships (supervisorships) are associated with a lower likelihood of earnings management. These findings are stronger after the GAAP was enacted, suggesting that the implementation of GAAP has lowered the likelihood of earnings management.

Table of Contents

ABSTRACT1

CHAPTER I: INTRODUCTION4

Introduction4

Background of the Study5

Theoretical Framework7

Research Questions9

Aims and Objectives9

Significance of the Study10

Methodological Overview10

CHAPTER II: LITERATURE REVIEW13

Corporate Governance Environment in United Kingdom13

Corporate Governance in the UK25

Earnings Management28

Motivations for Earnings Management30

Board structure and earnings management32

The role of outside directors32

The role of the CEO on the board33

Board size34

Ownership structure and earnings management35

Managerial ownership35

Adviser structure and earnings management36

Estimating Discretionary Accruals36

Corporate Governance and Earnings Management37

The newly enacted UK Generally Accepted Accounting Principles (GAAP)39

Related Research and Development of Hypotheses40

Independence41

Economic recession42

Voluntary formation of independent directorships and/or supervisorships44

CHAPTER III: METHODOLOGY45

Discretionary accruals45

Regression model46

Control variables48

Sample selection50

CHAPTER IV: RESULTS & FINDINGS54

Descriptive statistics54

Regression results61

Additional analyses66

Sensitivity analyses73

CHAPTER V: SUMMARY AND CONCLUSIONS75

REFERENCES79

CHAPTER I: INTRODUCTION

Introduction

The integrity of financial reporting has been a consistent concern among regulators and practitioners, especially after high-profile accounting scandals involving once well-respected companies such as Enron and WorldCom. Earnings management has also been a concern of regulators and practitioners for several years because it erodes the quality of financial reporting (e.g., Levitt, 2008 15).

In response to calls for strengthening corporate governance mechanisms to enhance the oversight function of the board of directors, and to restore public confidence in the integrity of financial reporting, the London Stock Exchange (LSE) and the FTSE 100 promulgated the UK Generally Accepted Accounting Principles (GAAP). The GAAP require companies listed on the LSE and the FTSE 100 to appoint independent directors and supervisors, including at least one financial expert, and to establish an audit committee. Motivated by the adoption of the newly enacted GAAP, we examine the association between these corporate governance mechanisms and earnings management in United Kingdom.

Prior studies address the importance of corporate governance in constraining earnings management in the US, the UK, and Canada (e.g., Beasley, 1996 98; Klein, 2008 15; Park and Shin, 2004 52; Peasnell et al., 2005 102), as well as in emerging markets (e.g., Claessens et al., 2006 78; La Porta et al., 2006 96; Kim and Yi, 2006 42). Our study differs from prior research that examines the relation between corporate governance and earnings management in emerging markets (e.g., Lee and Liao, 2004 215; Kim and ...