Audit Committees and Quarterly Earnings Management
Corresponding Author
Jagan Krishnan
Temple University
Jagan Krishnan, Temple University, Philadelphia, PA 19122, USA. Email: [email protected]Search for more papers by this authorCorresponding Author
Jagan Krishnan
Temple University
Jagan Krishnan, Temple University, Philadelphia, PA 19122, USA. Email: [email protected]Search for more papers by this authorAbstract
Regulators have frequently expressed concerns about corporate earnings management. Audit committees are expected to monitor managers’ financial reporting, including attempts to manipulate earnings numbers. The extant literature has focused on managers’ incentives to manipulate annual earnings numbers. However, managers also have incentives to manage quarterly earnings, due to, for example, pressures to meet quarterly analyst forecasts. We test the association between audit committee characteristics and measures of quarterly earnings management. Using a sample of 896 firm-year observations for the years 1996–2000, we report three findings. First, quarterly earnings management is lower for firms whose audit committee directors have greater governance expertise. Second, the extent of stock ownership by audit committee directors is positively associated with quarterly earnings management. Third, the average tenure of audit committee directors is negatively associated with quarterly earnings management.
REFERENCES
- Abarbanell, J. & Lehavy, R. (2003), Can stock recommendations predict earnings management and analysts’ earnings forecast errors? Journal of Accounting Research, Vol. 41, March, pp. 1–31.
- Bartov, E., Gul, F. A. & Tsui, J. S. L. (2000), Discretionary-accruals models and audit qualifications. Journal of Accounting and Economics, Vol. 30, December, pp. 421–452.
- Basu, S., Hwang, L. & Jan, C. (2000), Auditor conservatism and quarterly earnings. Working Paper, Baruch College, CUNY and California State University, Hayward.
- Beasley, M. S. (1996), An empirical analysis of the relation between board of director composition and financial statement fraud. The Accounting Review, Vol. 71, October, pp. 443–465.
- Beasley, M. S., Carcello, J. V. & Hermanson, D. R. (1999), Fraudulent Financial Reporting: 1987–1997, An Analysis of U.S. Public Companies. New York, NY: Committee of Sponsoring Organizations of the Treadway Commission (COSO).
-
Becker, C. L.,
DeFond, M. L.,
Jiambalvo, J. &
Subramanyam, K. R. (1998), The effect of audit quality on earnings management.
Contemporary Accounting Research, Vol. 15, Spring, pp. 1–24.
10.1111/j.1911-3846.1998.tb00547.x Google Scholar
- Bédard, J., Chtourou, S. H. & Courteau, L. (2004), The effect of audit committee expertise, independence, and activity on aggressive earnings management. Auditing: A Journal of Practice & Theory, Vol. 23, September, pp. 13–35.
- Booth, J. R. & Deli, D. N. (1996), Factors affecting the number of outside directorships held by CEOs. Journal of Financial Economics, Vol. 40, January, pp. 81–104.
- Burgstahler, D. & Dichev, I. (1997), Earnings management to avoid earnings decreases and losses. Journal of Accounting and Economics, Vol. 24, December, pp. 99–126.
- Burgstahler, D. & Eames, M. (2002), Management of earnings and analysts forecasts to achieve zero and small positive earnings surprises. Working Paper, University of Washington.
- Cahan, S. F. (1992), The effect of antitrust investigations on discretionary accruals: A refined test of the political-cost hypothesis. The Accounting Review, Vol. 67, January, pp. 77–95.
- Carcello, J. V. & Neal, T. L. (2000), Audit committee composition and auditor reporting. The Accounting Review, Vol. 75, October, pp. 453–467.
- Carcello, J. V. & Neal, T. L. (2003), Audit committee characteristics and auditor dismissals following ‘new’ going-concern reports. The Accounting Review, Vol. 78, January, pp. 95–117.
- Collins, W. A., Hopwood, W. S. & McKeown, J. C. (1984), The predictability of interim earnings over alternative quarters. Journal of Accounting Research, Vol. 22, Autumn, pp. 467–478.
- Dechow, P. M., Sloan, R. G. & Sweeney, A. P. (1995), Detecting earnings management. The Accounting Review, Vol. 70, April, pp. 193–225.
- DeFond, M. L. & Jiambalvo, J. (1994), Debt covenant violation and manipulation of accruals. Journal of Accounting and Economics, Vol. 17, January, pp. 145–176.
- DeFond, M. L. & Park, C. (2001), The reversal of abnormal accruals and the market valuation of earnings surprises. The Accounting Review, Vol. 76, July, pp. 375–404.
- DeZoort, F. T. & Salterio, S. E. (2001), The effects of corporate governance experience and financial reporting and audit knowledge on audit committee directors’ judgments. Auditing: A Journal of Practice & Theory, Vol. 20, September, pp. 31–48.
- Eisenberg, T., Sundgren, S. & Martin, M. T. (1998), Larger board size and decreasing firm value in small firms. Journal of Financial Economics, Vol. 48, April, pp. 35–54.
- Fama, E. F. & Jensen, M. C. (1983), Separation of ownership and control. Journal of Law and Economics, Vol. 26, June, pp. 301–325.
- Fama, E. F. & MacBeth, J. (1973), Risk, return, and equilibrium. Journal of Political Economy, Vol. 81, No. 3, pp. 607–636.
- Ferris, S. P., Jagannathan, M. & Pritchard, A. C. (2003), Too busy to mind the business? Monitoring by directors with multiple board appointments. Journal of Finance, Vol. 58, June, pp. 1087–1112.
- Gaver, J. J., Gaver, K. M. & Austin, J. R. (1995), Additional evidence on bonus plans and income management. Journal of Accounting and Economics, Vol. 19, February, pp. 3–28.
- Guay, W., Kothari, S. P. & Watts, R. (1996), Evaluating discretionary accrual-based models. Journal of Accounting Research, Vol. 34, Supplement, pp. 83–105.
- Han, J. C. & Wang, S. (1998), Political costs and earnings management of oil companies during the 1990 Persian Gulf crisis. The Accounting Review, Vol. 73, January, pp. 103–117.
- Healy, P. M. (1985), The effect of bonus schemes on accounting decisions. Journal of Accounting and Economics, Vol. 7, April, pp. 85–107.
- Hermalin, B. E. & Weisbach, M. S. (1991), The effects of board composition and direct incentives on firm performance. Financial Management, Vol. 20, Winter, pp. 101–112.
- Hribar, P. & Collins, D. W. (2002), Errors in estimating accruals: Implications for empirical research. Journal of Accounting Research, Vol. 40, March, pp. 105–134.
- Institute of Internal Auditors (IIA). (1991), The Audit Committee in Public Sector. Altamonte Springs, FL: IIA.
-
Jeter, D. C. &
Shivakumar, L. (1999), Cross-sectional estimation of abnormal accruals using quarterly and annual data: effectiveness in detecting event-specific earnings management.
Accounting & Business Research, Vol. 29, Autumn, pp. 299–319.
10.1080/00014788.1999.9729590 Google Scholar
- Jones, C. P. & Bublitz, B. (1990), Market reactions to the information content of earnings over alternative quarters. Journal of Accounting, Auditing and Finance, Vol. 5, Fall, pp. 549–566.
- Jones, J. J. (1991), Earnings management during import relief investigations. Journal of Accounting Research, Vol. 29, Autumn, pp. 193–228.
- Kaplan, S. N. & Reishus, D. (1990), Outside directorships and corporate performance. Journal of Financial Economics, Vol. 27, October, pp. 389–410.
- Kasznik, R. (1999), On the association between voluntary disclosure and earnings management. Journal of Accounting Research, Vol. 37, Spring, pp. 57–81.
- Klein, A. (2002), Audit committee, board of director characteristics and earnings management. Journal of Accounting and Economics, Vol. 33, August, pp. 375–400.
- Kosnik, R. D. (1990), Effects of board demography and directors’ incentives on corporate greenmail decisions. Academy of Management Journal, Vol. 33, March, pp. 129–150.
- Kothari, S. P., Leone, A. J. & Wasley, C. E. (2005), Performance matched discretionary accrual measures. Journal of Accounting and Economics, Vol. 39, February, pp. 163–197.
-
Kross, W. &
Schroeder, D. (1990), An investigation of seasonality in stock price responses to quarterly earnings announcements.
Journal of Business Finance and Accounting, Vol. 17, Winter, pp. 649–675.
10.1111/j.1468-5957.1990.tb00566.x Google Scholar
- McMullen, D. A. & Raghunandan, K. (1996), Enhancing audit committee effectiveness. Journal of Accountancy, August, pp. 79–81.
-
Mendenhall, R. R. &
Nichols, W. D. (1988), Bad news and differential market reactions to announcements of earlier-quarters versus fourth-quarter earnings.
Journal of Accounting Research, Vol. 26, Supplement, pp. 63–86.
10.2307/2491180 Google Scholar
- Millstein, I. M. (2002), Oversight Hearing on ‘Accounting and Investor Protection Issues Raised by Enron and Other Public Companies.’ US Senate Committee on Banking, Housing, and Urban Affairs. http://banking.senate.gov/02_02hrg/022702/millstn.htm.
- Parker, S. L. (2000), The association between audit committee characteristics and the conservatism of financial reporting. Working Paper, Santa Clara University.
- Pfeffer, J. (1983), Organizational demography. In L. L. Cummings & B. M Staw. (Eds.). Research in Organizational Behavior, 5, pp. 299–357. Greenwich, CT: JAI Press.
- Price Waterhouse (1993), Improving Audit Committee Performance: What Works Best. Altamonte Springs, FL: Institute of Internal Auditors Research Foundation.
-
Raghunandan, K.,
Read, W. J. &
Rama, D. V. (2001), Audit committee composition, ‘gray directors’ and interaction with internal auditing.
Accounting Horizons, Vol. 15, June, pp. 105–118.
10.2308/acch.2001.15.2.105 Google Scholar
- Reynolds, J. K. & Francis, J. R. (2000), Does size matter? The influence of large clients on office-level auditor reporting decisions. Journal of Accounting and Economics, Vol. 30, December, pp. 375–400.
-
Salamon, G. L. &
Stober, T. L. (1994), Cross-quarter differences in stock price responses to earnings announcements: Fourth-quarter and seasonality influences.
Contemporary Accounting Research, Vol. 11, Fall, pp. 297–330.
10.1111/j.1911-3846.1994.tb00445.x Google Scholar
- Scarbrough, D. P., Rama, D. V. & Raghunandan, K. (1998), Audit committee composition and interaction with internal auditing: Canadian evidence. Accounting Horizons, Vol. 12, March, pp. 51–62.
- Securities and Exchange Commission (SEC). (1999), Audit Committee Disclosure. Washington, DC: US Government Printing Office.
- Shivdasani, A. (1993), Board composition, ownership structure, and hostile takeovers. Journal of Accounting and Economics, Vol. 16, January/April/July, pp. 167–198.
- Subramanyam, K. R. (1996), The pricing of discretionary accruals. Journal of Accounting and Economics, Vol. 22, December, pp. 249–281.
- Subrahmanyam, V., Rangan, N. & Rosenstein, S. (1997), The role of outside directors in bank acquisitions. Financial Management, Vol. 26, Autumn, pp. 23–36.
- Teoh, S. H., Wong, T. J. & Rao, G. R. (1998), Are accruals during initial public offerings opportunistic? Review of Accounting Studies, Vol. 3, pp. 175–208.
- Wright, D. W. (1996), Evidence on the relation between corporate governance characteristics and the quality of financial reporting. Working Paper, University of Michigan.
- Xie, B., Davidson III, W. N. & DaDalt, P. J. (2003), Earnings management and corporate governance: The roles of the board and the audit committee. Journal of Corporate Finance, Vol. 9, June, pp. 295–314.
- Yermack, D. (1996), Higher market valuation of companies with a small board of directors. Journal of Financial Economics, Vol. 40, February, pp. 185–211.