Lucie Courteau

Corporate Governance and Earnings Management

This study investigates whether a firms corporate governance practices have an effect on the quality of its publicly released financial information. In particular, we examine the relationship between audit committee and board of directors characteristics and the extent of corporate earnings management as measured by the level of positive and negative discretionary accruals. Using two groups of US firms, one with relatively high and one with relatively low levels of discretionary accruals in the year 1996, we find that earnings management is significantly associated with some of the governance practices by audit committees and boards of directors. For audit committees, income increasing earnings management is negatively associated with a larger proportion of outside members who are not managers in other firms, a clear mandate for overseeing both the financial statements and the external audit, and a committee composed only of independent directors that meets more than twice a year. We also find that short-term stocks options held by non-executive committee members are associated with income increasing earnings management. Income decreasing earnings management is negatively associated with the presence of at least a member with financial expertise and a clear mandate for overseeing both the financial statements and the external audit. For the board of directors, we find less income increasing earnings management in firms whose outside board members have experience as board members with the firm and with other firms. We also find that larger board, the importance of the ownership stakes in the firm held by non-executive directors, and experience as board members seems to reduce income decreasing earnings management. Our results provide evidence that effective boards and audit committees constrain earnings management activities. These findings have implications for regulators, such as the Securities and Exchange Commission (SEC), as they attempt to supervise firms whose financial reporting is in the gray area between legitimacy and outright fraud and where earnings statements reflect the desires of management rather than the underlying financial performance of the company, as pointed out by the Blue Ribbon Committee (1999).

Audit Committee, Underpricing of IPOs, and Accuracy of Management Earnings Forecasts

Our results support the worldwide movement in legislations requiring AC independence and expertise. They stress the importance of the presence of qualified members on the AC with sufficient knowledge of accounting and finance. Our results suggest that the AC is a credible signal that could be used in the firms signaling strategy and the results provide support for the monitoring role of the board of directors, as proposed by the agency theory.Our empirical analysis is performed on a sample of 246 IPOs issued in the Canadian province of Quebec. We find that the creation of an AC at the time of the IPO has no effect on underpricing unless its members are independent and have expertise in financial matters, in which case it decreases significantly the level of underpricing of the IPO. However, we find no significant association between these two governance attributes and the accuracy of forecasts included in prospectuses. This paper examines the role of audit committees (AC) in the initial public offering (IPO) process in a governance environment where AC best practices are well established but their adoption is voluntary. We consider the creation and characteristics of the committee as signals that issuing firms can use to reduce the underpricing often associated with IPOs. We also examine the effect of the committee on the quality of management earnings forecasts included in the prospectus. This paper examines the role of audit committees (AC) in the initial public offering (IPO) process in a governance environment where AC best practices are well established but their adoption is voluntary. We consider the creation and characteristics of the committee as signals that issuing firms can use to reduce the underpricing often associated with IPOs. We also examine the effect of the committee on the quality of management earnings forecasts included in the prospectus. Our empirical analysis is performed on a sample of 246 IPOs issued in the Canadian province of Quebec. We find that the creation of an AC at the time of the IPO has no effect on underpricing unless its members are independent and have expertise in financial matters, in which case it decreases significantly the level of underpricing of the IPO. However, we find no significant association between these two governance attributes and the accuracy of forecasts included in prospectuses. Our results suggest that the AC is a credible signal that could be used in the firms signaling strategy and the results provide support for the monitoring role of the board of directors, as proposed by the agency theory. Our results support the worldwide movement in legislations requiring AC independence and expertise. They stress the importance of the presence of qualified members on the AC with sufficient knowledge of accounting and finance.