The purpose of this paper is to extend the existing literature by empirically examining the effect of board characteristics on earnings management (EM) from a developing region perspective. The study further adds literature by examining whether firm size moderates the relationship between board characteristics and EM. This study employs data drawn from 88 listed firms in the East African Community (EAC) for the period between 2011 and 2020. The study used the system generalized method of moments (SGMM) estimation model to take care of potential endogeneity and reverse causality. The findings revealed a positive and significant relationship between board size and EM. The findings further indicated that board independence, board gender diversity, and board financial expertise had a negative and significant effect on EM. In addition, the findings confirmed that firm size moderated the relationship between board size, board independence, board gender diversity, and EM. The insights of this study may provide useful information for shareholders and regulators in evaluating board attributes that are effective in mitigating earnings management practices from a developing region. Further, board effectiveness in deterring EM should be evaluated with regard to firm size. Just a few empirical studies have examined the relationship between board characteristics and EM in developing regions. Thus, this study contributes to the existing literature by empirically examining the topic in the EAC. Further, the study fills the existing gap in literature by examining whether firm size moderates the relationship between board characteristics and EM.
Accounting earnings are the most extensively used measure of firm financial performance. Given that financial reporting standards and accounting policies provide managers of a firm with considerable opportunities for manipulating earnings, it is not surprising that the growing attention in accounting literature has been devoted to understanding the determinants of earnings management. The collapse of once profitable and prominent corporations (Enron, Xerox, WorldCom, HealthSouth, Tyco, Waste Management, Rite Aid and Subeam, to mention a few) because of financial reporting fraud further reveals the harmful nature of EM. Healy and Wahlen (1999) define earnings management (EM) as what happens “when managers use judgment in financial reporting and in structuring transactions to alter financial reports to either mislead some stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers.” Flexibility in financial reporting (accounting methods and treatments) presents managers with opportunities by which they can manage earnings, which may either positively or negatively affect the quality of reported earnings and their value in the decision-making process (Goel, 2012). Research further confirms managerial motives in EM; for example, increasing executive stock-based compensation, avoiding debt covenants violation, earnings smoothing, and meeting or exceeding stock analysts’ forecasts (Kliestik et al., 2021).
5. Conclusions and recommendations
The incentives for managers to engage in unethical behaviours of managing earnings are constrained by board characteristics that determine its effectiveness. Therefore, this study examined the relationship between board characteristics and EM among listed firm in EAC. The study considered a sample of 88 firms and panel data for 2011 and 2020. In light of previous literature, the study focused on four dimensions of board characteristics: board size, board independence, board financial expertise, and board gender diversity. The findings showed that firms characterized by large boards are more likely to engage in EM. Inversely, the association between board independence, board gender diversity, board financial expertise, and EM was negative. These imply that the three dimensions effectively prevents opportunistic behaviors related to EM. In addition, this paper found support for considering firm size as a moderating factor between board characteristics and EM, which may explain the inconsistent findings on the impact of board dimensions and EM. Specifically, the study found that the interaction between board independence, board gender diversity, and firm size as significantly positive to EM. Further, the findings reveal that the interaction between firm size and board size minimizes EM. The moderation results of this paper enrich our understanding of how board characteristics are related to EM from the perspective of contingency approach.