Amsterdam Business School
MSc thesis
The effect of board characteristics on the level of earnings
management of Dutch listed firms
Name:Sander Robert van Houten
Student number: 6126979
Thesis supervisor: Georgios Georgakopoulos Word count: 18543
Date: 15 June 2016
MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam
Statement of originality
This document is written by student Sander van Houten who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.
Abstract
This paper examines the relation between multiple board characteristics (board meetings, number of non-executives, female non-executives, female executives, CEO tenure, executive compensation and non-executive compensation) and earnings management of Dutch listed non-financial firms. It is extremely exceptional that listed companies in the Netherlands have the possibility to choose between the two different board structures. Prior studies haven’t examined the differences between the structures and the relation of board characteristics and earnings management in the Netherlands.
The sample consists of 323 firm-year observations from 55 unique Dutch listed non-financial firms between 2004 and 2013. The analyses are done in three different situations. First, the whole sample size without distinctions. Second, a separate test is performed for companies containing an one-tier board structure and companies containing a two-tier board structure and lastly will the link separately be tested for firms in the pre-crisis period (2004-2007) and during the current financial crisis of 2008 (2009-2013). The proxy of earnings management is the value of the discretionary accruals, which is measured according to the modified Jones model.
After performing OLS regressions for all three situations, the main regression found significant positive relationships of the number of non-executives and non-executive compensation with earnings management. Indicating that more non-executives in the board and also a higher non-executive compensation is related with a higher amount of discretionary accruals. Furthermore, the female proportion and tenure of the CEO are inversely related with earnings management. The second regression found that the aforementioned board characteristics are more likely to affect earnings management in firms with a two-board than in firms with an one-tier board. Significant differences were found for the amount of non-executives, female proportion non-non-executives, CEO tenure and executive compensation. The third regression found that the board characteristics are more likely to affect earnings management in the period of the current financial crisis instead of the pre-crisis period. Significant differences were found for the amount of executives, proportion female non-executives, proportion female executives and non-executive compensation.
Key words: Earnings management, Corporate governance, (Non-)Discretionary accruals, The Netherlands
Table of Contents 1. Introduction ______________________________________________________________ 6 2. Literature review __________________________________________________________ 9 2.1 Theoretical background ____________________________________________________ 9 2.1.1 Agency Theory _________________________________________________________ 9 2.1.2 Earnings Management __________________________________________________ 10 2.1.2.1 Forms of Earnings Management _________________________________________ 10 2.1.2.2 Motives of Earnings Management _______________________________________ 12 2.1.3 Corporate governance and the board of directors _____________________________ 13 2.1.4 Financial crisis 2008 ____________________________________________________ 15 2.2 Hypothesis development __________________________________________________ 17 2.2.1 Conceptual model ______________________________________________________ 17 2.2.2 Board meetings ________________________________________________________ 18 2.2.3 Non-executive directors _________________________________________________ 19 2.2.4 Gender diversity _______________________________________________________ 20 2.2.5 CEO tenure ___________________________________________________________ 21 2.2.6 Executive and non-executive compensation _________________________________ 23 3. Research methodology ____________________________________________________ 28 3.1 Sample and data collection ________________________________________________ 28 3.2 Empirical design ________________________________________________________ 31 3.3 Measures ______________________________________________________________ 31 3.4 Measuring Earnings Management ___________________________________________ 33 3.5 Measuring board characteristics ____________________________________________ 35 3.6 Control variables ________________________________________________________ 36 4. Findings ________________________________________________________________ 37 4.1.1 Descriptive statistics hypothesis one _______________________________________ 37 4.1.2 Descriptive statistics hypothesis two _______________________________________ 38 4.1.3 Descriptive statistics hypothesis three ______________________________________ 41 4.2 Pearson correlation matrix_________________________________________________ 43 4.3 Regression results _______________________________________________________ 45 4.3.1 Regression results hypothesis one _________________________________________ 45 4.3.2 Regression results hypothesis two _________________________________________ 47 4.3.3 Regression results hypothesis three ________________________________________ 49 4.3.4 Additional analysis _____________________________________________________ 51 5. Conclusion ______________________________________________________________ 53
6. References ______________________________________________________________ 56 Appendices _______________________________________________________________ 61
1. Introduction
The past has shown a lot of economic scandals in relation to earnings management of large listed companies worldwide. These scandals have had a huge impact on the society and economy, and therefore should it be prevented in the future. Corporate governance is the mechanism to influence the possibility in developing these scandals.
One of the greatest scandals happened in the United States of America. The American energy, commodities and services company Enron went bankrupt in 2001 because of engaging in earnings management. Enron had a creative way of accounting in relation with their SPE’s (Special Purpose Entities). The entities were subsidiaries of Enron, and when some components of Enron became unprofitable, these components were sold to the SPE’s. Therefore, the loss figures didn’t show up on the balance of Enron. From the outside world it looked like they were incredible profitable. However, at the end of the story were two board members found guilty and had over more than 30,000 employees lost their jobs and remained with financial problems. This American scandal was very special because it was the first time in history that board members were held personally liable for the company they managed (BBC NEWS, 2002).
In the Netherlands, the Dutch food retailer Royal Ahold is the most known company in relation with earnings management. Royal Ahold is also called the ‘Dutch Enron’ (The Economist, 2003). In 2003, Ahold came into the spotlight of the supervisors because of the reported turnover in the financial statements of subsidiary US Foodservice. The reported turnover was much higher than the actual turnover, and after research some more discrepancies were discovered which led to the prosecution of the CEO and CFO of Ahold. Earnings management is defined in this thesis as the adjustment of a company's reported performance by insiders to mislead outside stakeholders (Leuz et al., 2003). Managers want to meet or beat earnings targets to build credibility, increase stock price, improve reputation of management team and realize future growth (Scott, 2011).
The examples of Enron, Royal Ahold and many others represent extreme situations of opportunistic behavior of managers that have undermined investors’ credibility and put directors and auditors under the scrutiny of regulators worldwide. In an attempt to recover investor confidence in the management of quoted companies, there has been an international trend in recent years towards developing and implementing good governance codes (Osma and Noguer, 2007). According to Laing and Weir (1999), new governance structures are designed to improve the quality of monitoring of board decisions. They conclude that the focus should be on board composition, i.e. board characteristics, in order to implement good
new governance structures.
The Netherlands has its own corporate governance code, The Dutch Corporate Governance Code, and differs from the corporate governance codes of other countries. The major difference is that listed companies in the Netherlands have the possibility to choose between two board structures (one-tier or two-tier), and prior studies haven’t examined the differences between the structures and the relation of board characteristics and earnings management a country where this choice is possible.
Akkermans et al. (2007) examined the application of the Dutch Corporate Governance Code. The findings indicate a high level of compliance with the Code of the Dutch listed firms in the first year after introduction. However, the authors conclude that it is premature to infer that the Dutch corporate governance code one year after its implementation has actually substantially affected corporate governance behavior (Akkermans et al., 2007, p. 1115). Therefore, a longer term perspective is needed to assess the actual impact of the Dutch corporate governance on company behavior. My study will provide the longer term perspective.
Furthermore, the thesis will shed a light on the relation of board characteristics and earnings management in the Netherlands. Prior research of Xie et al. (2003), Park and Shin (2004) and Osma and Noguer (2007) showed a strong relation of multiple board characteristics in relation with earnings management all over the world. However, this relation has never been examined in the Netherlands. Research has been done in countries including companies with initially one-tier board structures or just two-tier board structures, and in situations where no distinction between the two structures was made in the sample (Xie et al., 2003; Park and Shin, 2004; Osma and Noguer, 2007).
Because of the different corporate governance code in the Netherlands in relation to other countries and prior research on board diversity (Coffey and Wang, 1998), are the most important board characteristics, according to this thesis, that could affect earnings management in the Netherlands as follows, board meetings, executives, female non-executives, female non-executives, CEO tenure, executive compensation and non-executive compensation. Therefore, the contribution of this research is to find the effect of the characteristics of the board on the level of earnings management of Dutch listed non-financial firms, and help firms in order to choose the optimal structure of the board. The study will also contribute to investors and audit firms. Investors could use the findings in their investment decisions to estimate the likelihood for earnings management in Dutch firms, while audit firms could use the findings in assessing their risk model to estimate the likelihood for earnings management of their current clients, and whether to accept new clients.
The 2008 financial crisis had a huge impact on the Dutch economy and therefore will also a distinction be made regarding the period. The aforementioned relation hasn’t been tested in connection with the financial crisis in the Netherlands. The period before the crisis will be tested (2004-2007) and compared with the period of the current crisis (2009-2013). In the last few years, new changes1 are implemented to the Dutch Corporate Governance Code in order to strengthen corporate governance for listed firms the Netherlands. Changes were made regarding the remuneration of directors, diversity in the composition of the supervisory board, shareholder responsibility and the role of directors and supervisory board in acquisitions. This research reviews the consequences of these new regulations. When understanding the composition of board members in relation with earnings management, the Corporate Governance Committee could adjust the Code and make it more waterproof to prevent economic scandals related to earnings management in the future. Therefore the research question is:
RQ: What is the effect of board characteristics on the level of earnings management in Dutch listed firms?
In order to examine the impact of board characteristics on the earnings management of Dutch listed AEX and AMX firms, a quantitative archival study will be performed. The final sample period is stated for the years 2004-2013 and consists of 323 firm-year observations and 55 unique firms. The observed timeframe includes the period before the crisis (2004-2007) and the period of the current crisis (2009-2013). With the use of STATA, OLS regression analyses are made in order to conduct an answer on the research question for three situations. The first situation includes the total sample and analyses the results for the whole timeframe. Secondly, an analysis will be made regarding the differences between companies with an one-tier board structure and two-tier board structure. The last analysis applies to the differences of the pre-crisis and current pre-crisis period on earnings management.
This thesis is organized as follows, chapter two discusses the literature. This chapter describes the theoretical framework about the main subjects of this thesis, agency theory, earnings management, board characteristics and the economic crisis. This is the starting point for the three hypotheses, which will be contextualized in this chapter as well. Chapter three describes the data, sample and the model used for testing the hypotheses. Chapter four discusses the results and chapter five presents the conclusion.
1Dutch Corporate Governance Code adjustments, 2008,
2. Literature review
This section will provide a clear explanation of the main theory concepts and literature based on prior studies. These theories and literature are used to develop hypotheses, which are examined in order to answer the research question. Chapter two is separated into two parts. The first part includes theoretical background about the agency theory, earnings management board characteristics and the financial crisis of 2008. The second part describes the hypotheses development.
2.1 Theoretical background
In this paragraph the main theory concepts of the research will be emphasized. First, the agency theory will be used to describe the dependent variable, earnings management. Subsequently, the theory regarding earnings management is discussed and also the different types and motives. Afterwards, theoretical information regarding the board of directors is introduced, the characteristics of the two main types of board (one-tier board vs. two-tier board) are given, and the board characteristics is discussed. Finally, the theory regarding the economic crisis will be described. This is important background information in explaining why board characteristics influence earnings management.
2.1.1 Agency Theory
This study will use the agency theory to describe earnings management. Managers act in their own way instead of the way from the stakeholders. According to Jensen and Meckling (1976, p.308), an agency relationship is defined as a situation when a party (the principal) engage with another party (the agent) to perform some service on behalf of the principal which involves delegating some decision making authority to the agent. If both parties will act in a way that suits themselves, there is good reason to believe that the agent will not always act in the best interests of the principal. The principal can limit divergences from his interest by designing appropriate incentives for the agent and by incurring monitoring costs designed to limit the divergent activities, of the agent. The main issue is the expensiveness and/or difficultness to verify how the agent will act.
Jensen and Meckling (1976, p.310) state that the agency costs include the sum of the monitoring expenditures by the principal, the bonding expenditures by the agent and the residual loss. Fama and Jensen (1983, p.304) acknowledge this definition and state that agency problems arise because contracts are not costless written and enforced. Agency costs include the costs of structuring, monitoring, and bonding a set of contracts among agents with
conflicting interests. Agency costs also include the value of output lost because the costs of full enforcement of contracts exceed the benefits. Control of agency problems in the decision process is very important in cases where the decision managers are not the major residual claimants and therefore do not bear a great risk. These managers are more likely to take actions that deviate from the interests of residual claimants. (Fama and Jensen, 1983, p.304). The agency literature recognizes that the board of directors, specifically the composition of the board, is a mechanism that can mitigate agency conflicts within the firm. (Bathala and Rao, 1995).
2.1.2 Earnings Management
Leuz et al. (2003) define earnings management as the adjustment of a company's reported performance by insiders, such as controlling owners or managers, to mislead outside stakeholders. Healy and Wahlen (1999, p.368) complement this statement by saying that earnings management occurs when managers use judgment in financial reporting and in structuring transactions to alter financial reports to mislead stakeholders about the underlying economic performance of the company or to influence contractual outcomes that depend on reported accounting numbers.
Prior research by Leuz et al. (2003, p.506) mentions that investor protection is a crucial element that affects corporate policy choices. Also, incentives to engage in earnings management arise due to a conflict of interest between firms’ insiders and outsiders. Insiders can use their control over the firm to benefit themselves at the expense of other stakeholders. Furthermore, insiders have incentives to conceal their private control benefits from outsiders, because if these benefits are detected, outsiders are likely to take disciplinary action against them. Accordingly, the authors argue that insiders have incentives to manage reported earnings in order to mask true firm performance and to conceal their private control benefits from outsiders (Leuz et al., 2003).
2.1.2.1 Forms of Earnings Management
According to Scott (2011), there are four main forms of earnings management, namely big bath accounting, income minimization, income maximization and income smoothing. The first main form of earnings management, called ‘taking a bath’ or big bath accounting, is an one-time action technique to lower the current assets which will lead to a reduction of expenses in the future. Big bath accounting often occurs in periods where the firm got subsequent losses, because in this period it is often not functional for management to take actions for turning the losses into profits. Then, even a bigger reduction of the
performance won’t have a negative impact on the judgment of the financial statement users and therefore the management of the company reduces the current year earnings through accruals. In the next years, these earnings will be used to increase earnings because then are the earnings considered as more valuable. In these years, the accruals will be reversed easily without any notice of the financial statement users (Mohanram, 2003).
Scott (2011) defines income minimization as a more lenient variant of the taking a bath approach. Management will minimize the current income through heightened write offs and increase any expenses for current and future expenditures. The difference with big bath accounting is that this form won’t increase future profits but will lower the current income of the company. The reason behind this is that management prefer less attention regarding certain income tax considerations.
Income maximization is seen as the opposite of income minimization. The main target of this form is to maximize the income by boosting the discretionary accruals or engaging in real transactions in order to report a positive result (Scott, 2011). Prior research (Healy and Wahlen, 1999; Bartov and Mohanram, 2004) state the main motive to engage in this form, namely the achievement of bonus plans by managers. At the end of the year, the target should be achieved by the managers and therefore it is likely that managers will boost the earnings if the target is almost achieved. Another incentive to manage the earnings by maximize the income occurs in years of great firm performance. In those years, the bonus target will be easily held and therefore could management manage the residual earnings by lowering the current earnings. In the following years, management will increase those earnings through the use of discretionary accruals (Scott, 2011).
The fourth considered form of earnings management is income smoothing. Income smoothing is seen as the dampening of fluctuations in reported earnings over time (Ronen and Yaari, 2008, p.317). In other words, managers will manage the earnings by lower them in cases of relative high earnings, and higher them in cases of relative low earnings. According to Bao and Bao (2004) are managers willing to report a gradual growth by lowering the earnings in first instance, which corresponds with the private information of the firm about future earnings.
Additionally, earnings management could be divided into two types, namely accrual based earnings management and real based earnings management. Accrual based earnings management has been applied if accruals are intentional biased in order to mislead stakeholders about the underlying true economic performance (Healy and Wahlen, 1999, p.369). Accruals are used to record revenues and expenses in the period they are incurred. In other words, accruals are adjustments for revenues and expenses that have been earned but are
not yet recorded in the accounts. Through accruals it is possible for managers to manipulate the recording of revenues and expenses by booking unacceptable accruals according to the accounting standards. Some examples are asset impairments and losses from bad debts.
The other type is real based earnings management and focuses on real activities. Roychowdhury (2006, p.337) defines real based earnings management as deviations from normal operational practices by managers desire to mislead some stakeholders into believing certain financial reporting goals have been met in the normal course of operations. However, these deviations often don’t contribute to firm value or meeting the earnings target. When managers engage in activities more extensively than is normal with the objective of meeting an earnings target, they are engaging in real based earnings management. Some examples are price discounts to increase the sales and the reduction of discretionary expenditures.
2.1.2.2 Motives of Earnings Management
As already mentioned in this paper, the agency theory predicts why managers act in their own interest. Some incentives are already mentioned in this chapter, however Healy and Wahlen (1999) categorize the motivations into the following groups: capital market motivations, contracting motivations and regulatory motivations.
Capital market motivations are incentives to influence the short-term price performance of stocks by managers. According to Healy and Wahlen (1999), investors and financial analysts value stocks on the basis of financial accounting information. When the reported earnings are higher than expected, it is likely that the stock price of the firm will increase. This is because users of the financial statements become optimistic about future firm performance. Other prior research of Bartov et al. (2002) stated that in cases where firms reported higher earnings than expected by the financial statement users, there was also a greater abnormal stock return compared to firms that couldn’t meet the expectations. The second motive is related to contracts. Healy and Wahlen (1999, p.375) suggest that accounting data is used to help monitor and regulate the contractual relations between firms and stakeholders. To align these contracts for both parties, explicit and implicit management compensation contracts are used, as already mentioned at the agency theory. Prior research of Watts and Zimmerman (1990) suggest that managers with income-related bonuses are more willing to increase reported earnings from future to current periods.
The last motive is regulation. Watts and Zimmerman (1990) state that larger firms are more willing to reduce reported incomes than smaller firms. They state that firm size lead to political ‘heat’, and as a result could politicians reply with new taxes and/or other regulations (Scott, 2011).
2.1.3 Corporate governance and the board of directors
Corporate governance is a widely known concept in the literature and is also seen as the answer to agency problems. According to Merchant and Van der Stede (2007, p.553), the definition of corporate governance is the set of mechanisms and processes that help ensure that companies are directed and managed to create value for their owners while concurrently fulfilling responsibilities to other stakeholders (e.g. employees, suppliers and society).
Additionally, Bushman and Smith (2001, p.238) define the governance role of accounting information as the use of externally reported financial accounting data in control mechanisms that promote the efficient governance of corporations. Also, they state that corporate governance could be separated into two parts: internal control mechanisms and external control mechanisms. Internal control mechanisms include managerial incentive plans, director monitoring and the internal labor market. And external control mechanisms include outside shareholder or debtholder monitoring, the market for corporate control, competition in the product market, the external managerial labor market, and securities laws that protect outside investors against expropriation by insiders.
The board of directors play an important role with regard to corporate governance. Larcker and Tayan (2011) mention that the board of directors have two main important roles: to advise management and to monitor management’s activities. Advising management is defined as consulting with management regarding strategic and operating decisions, and monitoring management is defined as the way of monitoring managers in order to act in the best interest of shareholders. In accordance with the definition of Merchant and Van der Stede (2007), generally could be stated that the board of directors is a fundamental issue to help ensure that companies are directed and managed to create value for their owners while concurrently fulfilling responsibilities to other stakeholders (e.g. employees, suppliers and society).
The structure of the board of directors is a very important characteristic and has multiple different consequences based on which structure the firm has. Firms are able to have an one-tier board structure or a two-tier board structure. An one-tier board structure is characterized by a single board that includes executive and non-executive directors and therefore they have to operate together. The two-tier board structure is characterized by a separate management and supervisory board. Hereby, the management board contains the executive directors, and the supervisory board contains the non-executive directors. The executive board is responsible for the daily operational tasks and the main objectives of the non-executive directors are to monitor the executive directors, appoint new board members and approve the financial statements.
The advantage of an one-tier structure is that the communication between the board members is seen as more effective as a result of the presence of executive directors and non-executive directors in all face-to-face board meetings. On the other side, the independence of these directors is questioned. The opposite takes place at the two-tier board structure. In cases where there is a separation between the management board and the supervisory board, the communication is seen as less effective, because less face-to-face meetings take place between the two boards. However, these boards are considered as independent as long as the non-executives meet the applicable independence criteria of the corporate governance codes. The law determines whether companies are obliged to have an one-tier structure or a two-tier structure. In countries where common law is adopted, firms consist of one-tier board structures, e.g. the United States of America, the United Kingdom and Canada. In countries where code law is adopted, firms consist of two-tier structures, e.g. Germany (La Porta et al., 1999). However, there are exceptions, firms in the Netherlands and France are able to choose between the different board structures when they satisfy strict requirements.
The Netherlands has first introduced The Dutch Corporate Governance Code in 2003. The Code contains principles and best practice provisions that regulate relations between the management board, the supervisory board and the shareholders. It applies to all companies whose registered offices are in the Netherlands and whose shares or receipts for shares have been admitted to listing on a stock exchange, or more specifically to trading on a regulated market or a comparable system, and to all large companies whose registered offices are in the Netherlands (balance sheet value of total assets> € 500 million) and whose shares or receipts for shares have been admitted to trading on a multilateral trading facility or a comparable system (Corporate Governance Committee, 2009, p.5).
According to the Corporate Governance Committee (2009, p.11-12), the management board is responsible for achieving the company’s aims, strategy and policy, and results. The management board is accountable for this to the supervisory board and to the general meeting of shareholders. In discharging its role, the management board shall be guided by the interests of the company and its affiliated enterprise, taking into consideration the interests of the company's stakeholders. The management board shall provide the supervisory board in good time with all information necessary for the exercise of the duties of the supervisory board. The Corporate Governance Committee (2009, p.19) states that the supervisory board is responsible for supervising the policies of the management board and the general affairs of the company and its affiliated enterprise, as well as to assist the management board by providing advice. In discharging its role, the supervisory board shall be guided by the interests of the company and its affiliated enterprise, and shall take into account the relevant interests
of the company's stakeholders. The supervisory board is responsible for the quality of its own performance.
As already mentioned earlier in this chapter, firms in the Netherlands could choose between the board structures. Dutch listed firms may only choose for an one-tier board when they meet the following condition conforming to the Corporate Governance Committee (2009, p.28-29), the composition and functioning of a management board comprising both members having responsibility for the day-to-day running of the company (executive directors) and members not having such responsibility (non-executive directors) shall be such that proper and independent supervision by the latter category of members is assured. Furthermore, the following provisions are in place:
Ø The chairman of the management board may not also be or have been an executive director.
Ø The chairman of the management board shall check the proper composition and functioning of the entire board.
Ø The management board is responsible of the composition and role of three key committees of the supervisory board. The audit committee, the remuneration committee and the selection and appointment committee shall only consist of non-executive management board member. The function of the committees is to prepare the decision-making of the supervisory board.
Ø The majority of the members of the management board shall be non-executive directors and are independent according to the independence criteria of the Code.
2.1.4 Financial crisis 2008
From the beginning of the 70’s to 2008, the global economy had economic growth with continuously positive GDP growth rates. The gross domestic product (GDP) declined for the first time in 40 years in 2009. The financial crisis was most rigorous in Europe, the GDP growth rate declined to -4.30% vs. –2.05% for the world in general (Filip and Raffournier, 2014, p.457).
According to Ackermann (2008, p.330), there are two main causes underlying the financial crisis of 2008, namely the boom in US real estate markets and the high liquidity in the global financial markets. The price increases in the US real estate markets were fuelled by the monetary policy environment. At the same time, the boom in the US housing markets wouldn’t have been possible if it wasn’t facilitated by innovations in mortgage financing. One
of these innovations was the emergence of the subprime mortgage segment. These products allowed borrowers with impaired credit histories and low incomes to buy property. The increased liquidity was caused by the alleviation of US monetary policy which stimulated investments by firms and because of markets across the world had tied their exchange rate to the US-dollar and therefore applied a monetary policy similar to the US (Ackerman, 2008, p.330).
Furthermore, Ackermann (2008, p.331) argues that the spreading of the crisis was the outcome of globalization and securitization. Risks from US mortgage loans were distributed around the world. It could be seen as a welcome spreading of risk, but on the other hand it spreads the impact of the crisis as well. Also, to the extent that the distribution of risk is unknown, this produces additional uncertainty. As a result, while the crisis was initially limited to the US subprime segment and US mortgage financiers, it quickly spread to other institutions around the world that had invested in these securities (Ackermann, 2008).
Because the causes of the financial crisis were immediately obvious, it was easy to create improvements in order to respond to the crisis (Ackermann, 2008). Investors demanded greater transparency on the risks that banks held and their risk management. Francis et al. (2004) mentions that conservatism and timeliness can be considered as indicators of transparency. Currently, many banks put these risks on their balance sheet and also disclosures on banks’ positions have become more comprehensive, more detailed and more timely. Other areas to be addressed are valuation, risk management, market infrastructure, rating agencies and liquidity management (Ackermann, 2008). Authorities, standard-setters and financial institutions are addressing these issues with a high priority.
Balakrishnan et al. (2013) found evidence that firms during the financial crisis with more conservative financial reporting experienced less decrease in investment activity than firms with less conservative financial reporting. This implies that managers use investment decisions in order to manage the firms’ earnings.
Filip and Raffournier (2014) investigated the impact of the financial crisis on the earnings management behavior of non-financial firms listed in European markets. Their findings suggest an earnings management decrease over the crisis years (e.g. 2008– 2009) with respect to the pre-crisis period (e.g. 2006– 2007). More detailed, they found an income smoothing decrease during the crisis years associated with an increase of accruals quality. These findings are due to a higher market tolerance for poor performance. It can also be argued that litigation risk increases during crises, which should dissuade insiders to engage in earnings management. Finally, the change in the behavior of companies may also respond to a higher demand for more timely earnings in troubled periods (Filip and Raffournier, 2014,
p.473).
Another study done in Europe regarding earnings management before and after the outbreak of the financial crisis found opposed results. Iatridis and Dimitras (2013) researched the change of value relevance and earnings management of non-financial listed entities. Their findings suggest that some countries are more likely to engage in earnings management, and some other countries display less evidence of earnings manipulation (Iatridis and Dimitras, 2013, p.160).
Also Kousenidis et al. (2013) researched in Europe whether and how the financial crisis affects earnings quality by using conditional conservatism, timeliness, value relevance and earnings management. They analyzed listed non-financial entities over the period 2008– 2011. The countries analyzed are those with weak fiscal sustainability and that are under the supervision of the European authorities. For the period investigated, they considered fiscal years 2008 and 2009 as pre-crisis and the 2010–2011 as a crisis period. As to the evidence about earnings management, they found a reduction of manipulations after the financial crisis, due to a greater interest of entities in disclosing less smoothed and less managed earnings, because firms that rely on external financing and struggle with liquidity problems have very strong incentives for increasing their financial reporting quality in order to attract prospective investors (Kousenidis et al., 2013, p.351).
In summary, this research hypothesizes a reduction in earnings management during the financial crisis. The main reasons for this hypothesis are the increase of conditional conservatism during the financial crisis that should raise earnings quality and impair earnings management, and also the close monitoring activity of the auditor during the crisis contributes to an increase in the quality of financial reporting, which reduces earnings management due to the scrutiny of the auditor (Cimini, 2015).
2.2 Hypothesis development
In order to give an answer on the research question to what extent there is an effect of board characteristics on the level of earnings management, hypotheses will be developed in this section. These hypotheses will be formulated through an elaboration of previous literature.
2.2.1 Conceptual model
The figure below shows the conceptual model of the relations between the tested variables in this research. The main relation is between board characteristics and earnings management. Furthermore, the impact of the board structure will be tested on this relation, by testing the relation of the board characteristics on earnings management in cases where companies have
an one-tier board structure, and in cases where companies have a two-tier board structure. Also, the aforementioned main relation will be tested with a comparison between the period before and during the 2008 financial crisis.
Figure 1 : Conceptual model
2.2.2 Board meetings
This thesis will use the amount of board meetings as a board characteristic. In the US, board meetings have been researched in relation with earnings management by Xie et al. (2003). They found that the number of board meetings has a negative effect on earnings management for one-tier board companies. This implies that when boards meet more often, discretionary accruals are lower. This finding is consistent with the idea that an active board may be a better monitor than an inactive board.
Additionally, research done by Vafeas (1999) regarding the board meeting frequency and firm performance concludes that boards meet more frequently in periods of turmoil. Also they found that when boards meet more frequently, this has a positive impact on the financial performance. The argument for this is that a board that meets more often should be able to devote more time to issues such as earnings management. A board that rarely meets may not focus on these issues and may perhaps only approve automatically without proper consideration the plans of management (Xie et al., 2003, p.300). However, Jensen (1993) argues that board meetings are reactive instead of proactive measures. What indicates that
Independent variable: Board characteristics: - Board meetings - CEO tenure - Compensation - Gender diversity - Outsiders 1) Board structure 2) Pre- and current
financial crisis period
Dependent variable: Earnings management: - Modified Jones Model
firms respond to events with their number of board meetings. Those events will mostly negatively affect the firms’ performance.
Because of these prior researches, I expect a negative relation between the number of board meetings and earnings management. An active board is clearly a better monitor than an inactive board and a board which meets more often is able to devote more time to issues. In my opinion, this relation is more negatively related for firms with an one-tier board than for firms with a two-tier board. The reason for this is that at an one-tier board the non-executives are standing closer to the executives and could therefore better monitor and keep an eye on the executives’ actions. In the light of Vafeas (1999), who is arguing that firms meet more often in times of turmoil, I expect a greater negative relation in the period during the financial crisis between board meetings and earnings management.
2.2.3 Non-executive directors
As explained previously, non-executive directors of the board can serve as a significant force in minimizing agency problems between management and shareholders. Bathala and Rao (1995, p.60) suggest that outside directors are desirable because of their breadth of knowledge, experience, and independence from the management. The external members have their reputation as 'professional referees' at stake, and do not suffer from 'group think' or 'subordinate' modes of behavior to which internal members might possibly be prone. They are in turn disciplined by the market for their services which prices them according to their performance as referees (Bathala and Rao, 1995, p.60).
Adams and Ferreira (2009) studied the effect of supervisory board diversity on monitoring performance. They concluded that more diverse supervisory boards are related with a broader set of skills, views and opinions of supervisory board members. As a result it will increase the objectivity of the supervisory board and will improve the monitoring performance (Carter et al., 2003; Adams and Ferreira, 2009). Adams and Ferreira (2009) argue that the reason for increasing the supervisory board’s diversity is the reduction of the chances of possible collusions.
Dechow et al. (1995) and Beasley (1996) examined firms that have violated GAAP or have fraudulent financial reporting systems. Both studies find that a higher proportion of outside directors on a firm’s board is associated with greater confidence in the firm’s financial reporting system. There has been evidence that independent outside directors protect shareholders in specific instances when there is an agency problem (Xie et al., 2003).
Between the relation of outsiders and the level of earnings management is mixed evidence available. Park and Shin (2004) studied in Canada the effect of board composition
on earnings management. Their findings suggest that adding outside directors to the board may not achieve improvement in governance practices by itself. However, more and more studies claim that non-executive directors have a positive impact on the level of earnings management (Weisbach, 1988; Iqbal and Strong, 2010; Peasnell et al., 2005). Hermalin and Weisbach (1988) find evidence that non-executive directors are more likely to join the board of directors after a firm performs poorly and when a firm leaves a product market. Generally, I expect that the amount non-executive directors in the board has a positive impact on the level of earnings management due to a better monitoring of the executive directors. In one-tier board structures, I predict a stronger negative relation than two-tier board structures because of the more intensive monitoring and advising of the non-executives. Hahn and Lasfer (2011, p.590) state that the economic crisis resulted into the empowering of non-executive directors with responsibilities because of detailed strengthening of corporate governance codes or laws. Therefore, I expect that the relation between outsiders and the level of earnings management during the crisis will be more negative than before the financial crisis.
2.2.4 Gender diversity
The amount of female directors in the board is an upcoming corporate governance issue in the last years. Multiple corporate governance codes state a minimum percentage of female directors in the board of directors. In the Netherlands, the 30% gender test is introduced by the Dutch Act on Management and Supervision (‘Wet Bestuur en Toezicht’). The board of directors of listed firms should at least 30% be filled by male or female directors. The 30% gender rule is mandatory by the Dutch law, however firms are obliged to explain in the financial statements why the firm did not comply with the rule.
Female directors are very different than male directors. Female directors are seen as more ethical in the workplace and will less likely engage in unethical behavior to gain financial rewards (Betz et al., 1989). Arun et al. (2015, p.138) argue that women are better at obtaining voluntary information which may reduce information asymmetry between female directors and managers. Women are more cautious and less aggressive than men in a variety of decision-making contexts, and are less likely to take risks particularly in the financial decision environment. This will result in a greater likelihood of a restrained approach to earnings management (Arun et al., 2015, p.138; Gul et al., 2009).
Barua et al. (2010) researched the proportion of female directors in the board in relation to earnings management in the US. They found that US firms with one-tier board structures including more women in the board, are more likely to report higher quality
earnings. This is explained as a result of the tendency of female directors to abide by ethical values and regulations (Barua et al., 2010). In addition, Kyaw et al. (2015) and Arun et al. (2015) investigated the same relation in Europe. The findings also reveal that a gender diverse board mitigates earnings management in countries where gender equality is high and that firms with a higher number of female directors are adopting restrained earnings management practices.
Due to the above studies regarding gender diversity, this paper predicts a negative relationship between the amount of female executives and non-executives in the board and earnings management. This negative relationship is expected to be stronger in one-tier board structures due to more face-to-face meetings with the non-executives. During this meetings the female non-executives have more influence and will advise the male directors to make decisions more cautious and less aggressive.
2.2.5 CEO tenure
The chief executive officer (CEO) is seen as the most important person with the most influence in the firm. According to Epstein and Roy (2005, p.77-78), a CEO is evaluated by financial and non-financial measures, and therefore will these measures influence the CEO tenure. They state the following financial and non-financial measures:
Ø Financial performance Ø Strategic planning
Ø Management of customer relations Ø Management style
Ø Controls and risk management Ø Management of operations Ø Human resources management Ø Succession planning
Ø Management of external relations Ø Ethics and values
Ø Innovation
Ø Environment, health and safety
There is an inverse relation between the likelihood of CEO turnover and firm performance (Weisbach, 1988; Murphy and Zimmerman, 1993). Prior research from DeAngelo (1988) and Pourciau (1993) show that new CEOs associated with non-routine executive changes increase firms’ expenses in their first year. The new CEO will attribute the increased expenses to the
previous CEOs and takes credit for the resulting higher reported earnings in the subsequent years. According to Ali and Zhang (2015), the earnings overstatement is greater in the begin years than in the later years of CEOs' service, and this relation is less noticeable for firms with greater external and internal monitoring. These results suggest that new CEOs try to favorably influence the market's perception of their ability in their early years of service, when the market is more uncertain. Additionally, prior research (Dechow and Sloan, 1991; Pourciau, 1993; Ali and Zhang, 2015) found mixed evidence that CEOs in the last years of their tenure engage in earnings management. Some findings show that CEOs overstate firms’ earnings to boost their final year's pay and other findings showed no evidence because the CEOs are more likely to think about their future career.
The relation between the CEO tenure and the performance-turnover relation has been examined in the US by Dikolli et al. (2014). The authors display that a CEO’s performance-related dismissal becomes less likely as the CEO is more years in function. More detailed, Dikkoli et al. (2014) and Hermalin and Weisbach (1988) conclude the following about their research, CEO survival is associated with superior firm performance and this relation is unaffected by firm governance choices, the intensity with which a firm monitors its CEO declines over his tenure, and firms’ monitoring intensity increases following CEO turnover. An established CEO is more powerful than a new one, and therefore a more established CEO is a known quantity, so less scrutiny is required. Summarized, these results suggest that periodic performance reports increasingly resolve uncertainty regarding executive ability, thereby lowering shareholders’ demand for monitoring their CEO over his tenure (Dikkoli et al, 2014, p.281).
According to these previous studies, I expect that CEOs, with a longer tenure as CEO in the company, are less likely to engage in earnings management than CEOs with a shorter period. As mentioned, CEOs are more likely to engage in earnings management in the first years of their tenure to favorably influence the market's perception of their ability. Furthermore, at the later years, the CEO wont engage in earnings management because of their future career prospects. As stated in the second hypothesis, this paper predict no significant differences between the two board structures, because the CEO will remain the same motivation in both structures. However, in line with the third hypothesis, which is based on crisis period, I predict a less positive relation between CEO tenure and earnings management in the period during the crisis. The main reason is the increased monitoring of auditors and non-executives on the management of firms which causes that the CEO will be more cautious.
2.2.6 Executive and non-executive compensation
The structure of executive compensation is an important issue regarding corporate governance. With the use of the structure of executive compensation is the board of directors able to steer the decision making of executives in a favorable direction. Originally is the goal of the board of directors is to encourage executives in order to maximize firm profitability by aligning executives’ self-interest with shareholders’ interest (Craighead et al., 2004).
The compensation structure of executives has three key components, namely base salary, short-term compensation and long-term compensation (Mahoney and Thorn, 2006). The base salary is a fixed fee that the executive will certainly receive and therefore isn’t closely tied to firm performance. The incentive-plan could be short-term in nature (cash payment or bonus) and long-term (stock options). The short-term compensation is seen as a performance-based compensation. It is contingent on pre-established performance criteria which the executives should meet. Compensation committees tie cash compensation to these pre-established performance criteria to align the executives’ incentives to those of the shareholders, as well as for tax considerations (Ibrahim and Lloyd, 2011, p.259).
According to Kaplan and Atkinson (1989), incentive plans that include earnings-based performance measures are frequently criticized for encouraging executives to focus on maximizing short-term reported earnings rather than the economic well-being of the firm. The concern is that executives may select real decisions and accounting procedures to maximize their earnings-based compensation, instead of maximizing the firm profitability (Kaplan and Atkinson, 1989; Watts and Zimmerman, 1990). Watts and Zimmerman (1990) state that managers of firms with bonus plans are more likely to choose accounting procedures that shift reported earnings from future periods to current periods and vice versa. Healy (1985) substantially documents that executives manage earnings upwards when earnings fall below the minimum bonus payment threshold and manage earnings downwards when their bonus payment is at its maximum level (Ibrahim and Lloyd, 2011, p.259).
Jones and Wu (2010) examined the effects of executive compensation and potential for earnings management on the incidence of shareholder class action lawsuits and their outcomes. They found a positive relation between costly settlement and executive option compensation. This provides stronger evidence that option compensation increases the incentive to manipulate earnings and firm vulnerability to penalty by shareholder lawsuits. Consequently, it suggests that managers with more executive option compensation are more likely to engage in earnings management. However, Laux and Laux (2009) show that an increase in CEO equity incentives does not necessarily increase earnings management because directors adjust their oversight effort in response to a change in CEO incentives. If
the board's responsibilities for setting CEO pay and monitoring are separated through the formation of committees, then the compensation committee will increase the use of stock-based CEO pay, as the increased cost of oversight is borne by the audit committee (Laux and Laux, 2009, p.885).
The expectation of my research is that a positive relation exist between executive compensation and earnings management. The main reason for this is that directors will select real decisions and accounting procedures to maximize their earnings-based compensation. This research won’t predict a significant change in the relation of executive compensation and earnings management between firms with different board structures. The different conditions of these board structures are expected to not affect this relation. Also, no significant change in the relation is expected between the period of pre-crisis and period during the crisis.
Research that examines the compensation of non-executives is very scarce. This has three different reasons according to Hahn and Lasfer (2011). Namely, the actual contributions of non-executives remain unclear. Also, the governance codes have not discussed the ways in which non-executive directors should undertake their roles and at last may non-executive director contribution be unobservable. This results in actions of the non-executives that are very difficult to measure.
The compensation structure of non-executive directors have the following key components: base salary according to role, fee per attended meeting and fee for the occupied committee. In the Netherlands are three key committees, namely the audit committee, the remuneration committee and the selection and appointment committee. The amounts for the compensation structure are determined at the general shareholders’ meeting.
Goh and Gupta (2015) examined the remuneration of non-executive directors by examining individual monitoring characteristics and director capital in addition to firm characteristics. They found that remuneration is positively linked to both directors' individual characteristics and firm characteristics. Another finding is that non-executive remuneration is negatively related to monitoring characteristics (e.g. director independence). These findings will suggest possible agency considerations, because less is being paid for the effective monitoring of top management.
Yermack (2004) argues that the lack of a competitive labor market for non-executive directors results in fewer incentives for these members to act on behalf of shareholders. This theory suggests that non-executives act on behalf of themselves because they don’t have any power over the board of directors. In addition, Ryan and Wiggins (2004) mentions that the managerial power theory is related to non-executive director compensation and therefore a positive relationship between non-executive compensation and earnings management exist.
Hahn and Lasfer (2011, p.590) state that the economic crisis resulted into a detailed strengthening of corporate governance codes or laws resulting in the empowering of non-executive directors with responsibilities but seem to have avoided discussion of non-non-executive director remuneration in relation to such responsibilities. Because of the scarce research regarding non-executive compensation, and even no research regarding the relation between non-executive compensation and earnings management, this paper has no clear expectation about this relation.
Based on previous research, the following hypotheses are tested in this research:
H1: The elaborated board characteristics of Dutch listed companies have the association with earnings management according to table 1
Table 1: Predictions regarding hypothesis 1
Dependent variable
Earnings management (Non-discretionary accruals)
Independent variable Predicted sign.
Meetings -Non-executives -Female non-executives ? Female executives -CEO tenure -Executive compensation + Non-executive compensation ?
Notes: This table shows the predicted significances of the relation between the tested independent
variables (board characteristics) and the dependent variable (earnings management) according to hypothesis one. The sample includes Dutch listed firms between 2004-2013. + Means a positive relationship, – a negative relationship and ? is an unknown predicted association.
H2: The elaborated board characteristics of Dutch listed companies with an one-tier board structure and companies with a two-tier board structure have the association with earnings management according to table 2
Table 2: Predictions regarding hypothesis 2
Dependent variable
Earnings management (Non-discretionary accruals)
Panel A: One-tier board Panel B: Two-tier board
Independent variable Predicted sign. Predicted sign.
Meetings - --Non-executives -- -Female non-executives ? ? Female executives - -CEO tenure - -Executive compensation + + Non-executive compensation ? ?
Notes: This table shows the predicted significances of the relation between the tested independent
variables and the dependent variable in two situations according to hypothesis two. A separation for the situations is made regarding the board structure. Panel A includes the Dutch listed firms with an one-tier board structure and panel B contains the Dutch listed firms with an two-tier board structure. The sample period is 2004-2013. + Means a positive relationship, – a negative relationship and ? is an unknown predicted association.
H3: The elaborated board characteristics of Dutch listed companies with the timeframe before the financial crisis and companies with the timeframe during the current financial crisis have the association with earnings management according to table 3
Table 3: Predictions regarding hypothesis 3
Dependent variable
Earnings management (Non-discretionary accruals)
Panel C: (2003-2007) Panel D: (2009-2013)
Independent variable Predicted sign. Predicted sign.
Meetings - --Non-executives - --Female non-executives ? ? Female executives -- -CEO tenure -- -Executive compensation + + Non-executive compensation ? ?
Notes: This table shows the predicted significances of the relation between the tested independent
variables and the dependent variable in two situations according to hypothesis three. A separation for the situations is made regarding the sample period, namely the period before the financial crisis (2003-2007) and the period during the current financial crisis (2009-2013). Panel C includes Dutch listed firms before the crisis and panel D includes the Dutch listed firms during the crisis. + Means a positive relationship, – a negative relationship and ? is an unknown predicted association.
3. Research methodology
In this section are the sample, data collection, empirical design and methodology of the research discussed. In order to examine the impact of board characteristics on earnings management of Dutch listed firms of the AEX and AMX, a quantitative archival study will be performed and analyzed by using STATA. The multiple regression analyses will be used to discover any significant associations between the dependent and independent variables.
3.1 Sample and data collection
In order to give a clear view on the aforementioned relation, a timeframe of 2004-2013 has been chosen. Another reason was the availability of the required data. The final sample size includes 323 firm-year observations of 55 unique Dutch listed AEX and AMX firms in the stated timeframe. In appendix B are all the tested Dutch listed companies stated. The timeframe includes the period before the financial crisis of 2008 (2004-2007), outbreak of the financial crisis (2008) and the period of the current financial crisis (2009-2013). Therefore, this study will compare the pre-crisis period and ongoing crisis period in order to discover any differences. Table 5 displays the steps that were involved to finalize the sample selection and table 6 shows the amount of firm-year observations per year. The distribution is divided proportionally.
In this sample, all firms from the financial services industry are excluded (i.e. banks and insurance companies with SIC codes 6000-6999). The reason of this is that the financial services industry have special unique regulations and the firms have specific characteristics which are completely different from the firms in other industries. More detailed, the accruals are likely to be different from accruals of firms in the other industries.
Table 4 includes the amounts of the tested firm-year observations per specific industry. The results show that the manufacturing industry has the most firm-year observations, namely 153. Hereafter, Services and Construction are the industries with the highest number of firm-year observations, respectively 65 and 36.
The required data of the independent variables of the board characteristics (board meetings, number of non-executives, female non-executives, female executives, CEO tenure, executive compensation and non-executive compensation) is mostly hand collected from the registered annual reports of the Dutch companies and companies’ websites. A small part of the sample is collected from the executive search consulting firm SpencerStuart. This consulting firm provides a database of board composition and director compensation at firms listed on the Dutch segment of the NYSE Euronext, including members of the AEX and
AMX indices.
Furthermore, the required data to measure the dependent variable (earnings management, by using the discretionary accruals) is extracted from the database Osiris. Osiris has mostly the required detailed financial information of listed companies in the Netherlands for the tested timeframe, however 232 firm-year observations were lost because of these database results.
Table 4: Firm-year observations per industry
Industry SIC Number of firm-year observations
Agriculture, Forestry and Fishing 0100 – 0999 0
Mining Construction Not used 1000 – 1499 1500 – 1799 1800 – 1999 17 36 0 Manufacturing 2000 – 3999 153 Transportation, Communication, Electric, Gas and Sanitary
4000 – 4999 35
Wholesale Trade Retail Trade
Finance, Insurance and Real Estate
5000 – 5199 5200 – 5999 6000 – 6799 4 13 0 Services 7000 – 8999 65 Public administration Non classifiable 9100 – 9729 9900 – 9999 0 0
Notes: This table shows the amount of firm-year observations sorted per specific industry for the
timeframe 2004-2013. The figures are based on the Standard Industrial Classification codes and are extracted from the Osiris database. 2-Digit Standard Industrial Classification (SIC) codes are retrieved from the North Carolina State University, available at:
Table 5: Sample selection
Firm-Year Observations
Initial sample (2004-2013) 640
Less: missing data for measuring earnings management (232) Less: firm-year observations banks and financial
institutions (SIC 6000-6999)
(60)
Less: winsorized data of variables (25)
Final sample (2004-2013) 323
Final unique firms (2004-2013) 55
Notes: This table shows the steps that were involved to finalize the sample selection
in the period 2004-2013.
Table 6: Final Sample Distributional Properties
Year Firm-Year Observations % of Sample
2004 26 8,0 2005 34 10,5 2006 32 9,9 2007 33 10,2 2008 30 9,3 2009 36 11,2 2010 32 9,9 2011 33 10,2 2012 31 9,6 2013 36 11,2 Total 323 100%
Notes: This table shows the number of firm-year observations per year. The second
column displays the amount of firm-year observations per year in proportion of the total number of firm-year observations.
3.2 Empirical design
The following empirical model is used to conduct a regression analyses in order to measure the effect of the board characteristics on earnings management:
DACabs = β0 + β1 MEETINGS + β2 SIZENONEX + β3 GENDERNONEX + β4 GENDEREX + β5 CEOTENURE + β6 EXCOMP + β7 NONEXCOMP + β8 GROWTH + β9 SALESGROWTH + β10 LNSIZE + β11 SIC + β12 TIER + β13 CRISIS + ε
In order to control for biased findings, this study will use some initial checks. First, the variables are checked for linearity and unusual cases. This is done according to the use of scatterplots in STATA. These scatterplots showed some outliers, but did not show a lack of linearity. In order to control for these outliers, are all the variables winsorized. The next step is to check the residuals for linearity, homoscedasticity, independence and normality. The findings show that all the assumptions are met and no bias was identified.
3.3 Measures
This study will use the following board characteristics to conduct an answer on the research question:
- Board meetings
- Number of non-executives
- Proportion female non-executives - Proportion female executives - CEO tenure
- Executive compensation - Non-executive compensation
See below table 7 for a detailed explanation of all the variables (dependent, independent and control variables) that are used in the mentioned equitation’s.
Table 7: Definition of the variables
Variable Acronym Definition
Dependent variable
- Earnings management EM - The level of accruals over which managers can exercise some control through accounting discretion and estimates
Independent variable - Board tier
- Board meetings
- Dummy Crisis
- Number of non-executive directors
- Proportion female executive directors
- Proportion female non-executive directors
- CEO tenure
- Compensation executive directors
- Compensation non-executive directors
- SIC code TIER MEETINGS CRISIS SIZENONEX GENDEREX GENDERNONEX CEOTENURE EXCOMP NONEXCOMP SIC
- Dummy variable, indicates whether the company board consists of a combined board (1 tier = 1) or has a separate managing and
supervisory board (2 tier = 0)
- Total number of board meetings in specific year
- Dummy variable; indicates the period, pre-crisis =0 the current-pre-crisis =1
- Total number of non-executive directors in the board
- Fraction of female executive directors in the board
- Fraction of female non-executive directors in the board
- Length of time in years the CEO is in function - Average fixed compensation including short-and long-term bonuses (paid in cash) of
executive directors in the board (x1.000 in EUR) - Average fixed compensation of non-executive directors in the board (x1.000 in EUR)
- SIC code clarifies the specific industry of the company Control variables - Sales Growth - Growth - Firm size SALESGROWTH GROWTH LNSIZE
- Annual percentage sales growth of total sales - Annual percentage assets growth of total assets - Logarithmic function of the average total assets of the current and prior year
Accruals
- Discretionary accruals
- Total assets - Total accruals
- Change in current assets
- Change in current liabilities
- Change in cash and cash equivalents
- Depreciation
- Short term debt in liabilities
- Change in receivables
- Change in revenues
- Gross property, plant and equipment
- Non-discretionary accruals - Firm-specific parameters DACabs A TA ΔCA ΔCL ΔCash Dept ΔSTD ΔREC ΔREV PPE NDA β1, β2 and β3 εt
- The level of discretionary accruals in absolute value
- The total assets of the firm
- The total number of accruals measured in total assets for a certain period t
- Net current assets at time t less net current assets in the previous year
- Net current liabilities at time t less net current liabilities in the previous year
- Cash and cash equivalents in current year less cash and cash equivalents in the previous year - Depreciation and amortization expense at time t
- Net debt included in current liabilities at time t less net debt included in current liabilities in the previous year
- The change in receivables over a certain period t
- The change in revenues over a certain period t - The gross property, plant and equipment at time t
- The accruals not explained by the firm-specific information
- Regression coefficient estimates
- Residual of firm at time t, which represents the discretionary accruals and which measures earnings management
Notes: This table shows a detailed explanation of all the variables (dependent, independent and control
variables) that are used in the mentioned equitation’s.
3.4 Measuring Earnings Management
The proxy for earnings management is the value of the discretionary accruals. This research will use the absolute value of discretionary accruals, because earnings manipulation involves both extremely positive and negative values of discretionary accruals (Klein, 2002). Past research to study accruals use two models, Healy (1985) and DeAngelo (1986) use total
