Does Increased Board Independence Reduce Earnings Management? Evidence from Recent Regulatory Reforms

Abstract

In this paper, we examine whether recent regulatory reforms requiring majority board independence are effective in reducing the extent of earnings management. Firms that did not have a majority of independent directors prior to the reforms (referred to as non-compliance firms) are required to increase their board independence. We find that, while non-compliance firms on average do not experience a significant decrease in earnings management after the reforms compared to other firms, non-compliance firms with low information acquisition cost experience a significant reduction in earnings management. The results are similar when we examine audit committee independence and when we use alternative proxies for information acquisition cost and earnings management. These findings indicate that independent directors’ monitoring is more effective in a richer information environment.

Keywords: earnings management, corporate governance, board independence, information environment

JEL Classification: G32, M40