M A S T E R T H E S I S A C C O U N T A N C Y
T H E R E L A T I O N B E T W E E N S O C I A L D O M I N A N C E O F T H E C E O , E A R N I N G S M A N A G E M E N T A N D T H E I N F L U E N C E O F ( F E M A L E R E P R E S E N T A T I O N I N ) T H E A U D I T C O M M I T T E E P O M M E L I E N H O V E N K A M P / / S 2 2 0 5 1 0 6 / / U N I V E R S I T Y O F G R O N I N G E N / / S U P E R V I S O R : D R . D . B . V E L T R O P / / C O - A S S E S S O R : D R . S . M U K H E R J E E / / 2 0 - 0 6 - 2 0 1 7 / / W O R D C O U N T : 6 1 5 6 ABSTRACT:In this paper, the relationship between social dominance of the CEO and earnings management is examined. Moreover, this paper examines whether (female representation in) the audit committee moderates this relationship. The research is conducted by using a sample of 128 not-for-profit organisations. A regression analysis shows no significant relationship between social dominance of the CEO and earnings management. This conflicts with the hypothesis, which expected that, because social dominant CEOs do have much influence on the audit committee, the committee remains dependent and is therefore not able to monitor management properly. As a result, opportunities for earnings management should arise. However, according to the stewardship theory, managers do not always behave as opportunistically as presumed by the agency theory, which could be a reason for this contradicting evidence. Moreover, the results show no moderating influence of (female representation in) the audit committee on the relationship between social dominance of the CEO and earnings management. This could perhaps be declared from the social categorization theory. To conclude, despite no significant relationships were found, the findings are relevant, because this research opens the ’black box’ concerning behaviour in the boardroom.
KEY WORDS: social dominance, earnings management, audit committee, agency theory, gender diversity
TABLE OF CONTENT
1. INTRODUCTION ... 3
1.1 Research subject & relevance ... 3
1.2 Structure research ... 5
2. THEORY SECTION ... 5
2.1 Earnings management ... 5
2.1.1 Agency theory ... 6
2.2 Social dominance CEO ... 7
2.3 Audit committee ... 8
2.4 Women in the audit committee ... 9
3. METHOD SECTION ... 11 3.1 Research setting ... 11 3.2 Sample ... 11 3.3 Measures ... 11 4. RESULTS ... 14 5. DISCUSSION ... 17 5.1 Conclusion ... 17
5.2 Limitations and implications for further research ... 18
REFERENCES ... 20
1 . INTRODUCTION
1.1 Research subject & relevance
In the last decade, a lot of large firms where accused of massive accounting frauds caused by earnings management (for example Enron & WorldCom). Due to the manipulation of earnings by management, stakeholders do not receive a fair representation of the truth. This suggests that (potential) shareholders regularly have to make investment decisions based on false reports. Therefore, shareholders, investors and society rely less on the financial reporting process (Bruynseels & Cardinaels, 2013).
In 2003, in response to these scandals, the Securities and Exchange Commission (SEC) came with regulations concerning corporate governance (Chen et al., 2015). Sarbanes- Oxley Act (SOX) came up with provisions in 2002. They, however, focus on the responsibilities of the audit committee (Chen et al., 2015). An important aspect of the sharpened corporate governance codes is the mandatory nature of an audit committee, which is a sub-committee of the board (Ghafran & O’Sullivan, 2013). Members of an audit committee meet on regular base with the firm’s internal financial managers and external auditors to review the corporation’s financial statements, audit process, and internal accounting controls (Klein, 2002; Cohen; 2012). Director characteristics such as independence and financial expertise are crucial in the provisions of SOX (DeFond et al., 2005). This should result in a higher quality of financial reporting, which is necessary for (potential) shareholders and other stakeholders of the firm. According to Park & Shin (2002) and Xie et al. (2003), boards, especially the audit committee, may play a role in limiting the practise of earnings management. However, despite the accounting rules and financial reporting standards there are still considerable opportunities for earnings management.
An important reason for this may be that boards of directors and audit committees are human decision-making groups. The functioning of the board, and in particular that of the audit committee vis-à-vis the CEO, is influenced by behavioural factors operating between the audit committee and executives. Evidence is found by Bruynseels & Cardinaels (2013). For instance; their research indicates that the oversight quality by audit committees depends on social ties outside the audit committee. Moreover, the literature on boards emphasises the need for an improved and more behaviourally oriented understanding of boards (Veltrop, 2012; Forbes & Milliken, 1999; Hambrick et al., 2008; Hillman et al., 2008). Therefore, to
fully understand how audit committees affect earnings management, it is important to study the behavioural dynamics that operate between audit committees and the CEO.
According to Barclift (2011), “CEOs can have profoundly important effects on all aspects of corporate governance because the fulcrum of governance is the chief executive officer”. Previous research considers social power to be the influence of the CEO over the board of directors (Barclift, 2011). This is expressed in the fact that the board of directors is often appointed from within the informal social networks of CEOs (Finkelstein & Hambrick, 1996). However, although personality characteristics are considered less frequent in previous research, they have great influence. Therefore, social dominance of the CEO is important when examining the working relationship between the audit committee and the CEO. I define social dominance as a personality trait to explain why audit committees are not fully independent from the CEO, which could result in poor monitoring. Beasley et al. (2009) argue that some audit committees only play a ceremonial role, instead of a monitoring one. Also according to Vance (1983), it will be difficult for the audit committee to provide effective oversight over managerial decisions and activities when a CEO is socially dominant. This is a real problem when striving for good governance.
A possible solution for the, often harmful, effects of dominant CEOs rather than solely focus on financial expertise, is increasing the diversity in the board of directors (Barclift, 2011). In general, researchers believe that gender diversity in the board results in more independence and a better position to monitor the CEO (Srindhi et al., 2011; Hillman et al., 2007; Sigh et al., 2008; Hillman et al., 2002; Adams & Ferreira, 2009). According to Chen et al. (2015), more independent board members (for example women) are not as subjected to the influence of CEOs and can therefore be more objective. As a result of this improved monitor position, opportunities to manipulate earnings could be reduced. As far as I know this is not researched before. Therefore, it is important to implement the moderator female representation in the audit committee in this research.
To conclude, when one tries to combat earnings management it is important to look at the social factors that may play a substantial role besides the regulation. While prior studies have found that earnings management could be reduced by formal corporate governance characteristics (Cornet et al., 2008; Klein, 2002; Dechow et al., 1996; Beasley, 1996) such as age and tenure of the CEO, ultimately, a board carries out its duties vis-à-vis the CEO, and, in that respect, social factors play a potentially important role. This research accesses a unique
dataset, which consists out of data from Dutch non-profit organisations, which enables measuring CEO social dominance and social processes operating between the CEO and the board. Because the elite nature of boards makes this difficult to realize, this has not been studied before (Veltrop, 2012; McNulty & Pettigrew, 1991; Pettigrew, 1992). This research is relevant as it tries to open up the ‘black box’ in the boardroom, in trying to understand how social forces between the CEO and the board impact earnings management of organisations.
What is the influence of social dominance of the CEO on earnings management and how does (female representation in) the audit committee influence this relationship?
1.2 Structure research
The remainder of the paper is organised as follows: in section two, relevant literature is reviewed in order to establish the hypothesis; in the third section, the method is described; in the fourth section, the empirical analyses and results are provided and, in the last section, concluding remarks are given.
2 . THEORY SECTION
2.1 Earnings management
For years, firms have used the latitude of accounting rules to manipulate earnings in different ways (Cornet et al., 2008). In other words: earnings management is not something new. However, it is remarkable that Cohen et al. (2005) show an increase in earnings management from 1997 until 2002. As a result of this increase and recent fraud scandals, earnings management became popular in the academic world and public press. In this thesis, earnings management is defined according to the definition of Healy & Wahlen (1999): “Earnings management occurs 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”. Shafer (2015) describes earnings management as a “critical ethical issue for the accounting profession”. This is important because it illustrates that manipulating earnings is often not illegal and CEOs do comply with existing laws. However, it is not moral, because CEOs do not provide fair financial information, which is expected from them by stakeholders.
2.1.1 Agency theory
Earnings management could be explained by the agency theory. One could describe the agency relationship as “one in which one or more persons (principals) engages another person (the agent) to perform some service on their behalf which involves delegating some decision- making authority to the agent” (Jensen & Meckling, 1976; Ross, 1973; Hill & Jones, 1992). In other words, there is a separation between control and ownership. The CEO (the agent) has to act in the interest of the owners/ shareholders (principals). This is difficult, however, because CEOs have different interests compared to shareholders and, therefore, often behave opportunistically. First of all, career perspectives of the CEO could be a driving force for earnings management. According to Fudenberg & Tirole (1995), CEOs manipulate earnings to secure their job. Moreover, CEOs use earnings management to maintain their reputation, because they are able to present persistent good results (Graham et al., 2005; Scott, 2012, p. 435). Bowen et al. (1995) argue that CEOs need their reputation in order to obtain benefits from relations with stakeholders such as clients, suppliers, employees and lenders. Besides that, CEOs want to prevent violating debt covenants, which are based on earnings, and could therefore decide to manipulate earnings (Chong, 2006). Another motive to manage earnings is to ensure compensation and bonuses, especially when the compensation of the CEO depends on the stock price. For instance, CEOs manipulate earnings to a lower level when the bonus is at the highest level (Healy, 1985). According to Chong (2006), CEOs smooth earnings “to project a better-than-expected level of performance not only for the current year, but also in the forthcoming periods”. Finally, firms use earnings management to meet the expectations of the capital market (Jiraporn et al., 2008).
Apart from the different interests, the risk preference between shareholders and CEOs diverges as well, which is probably a reason for earnings management. According to Eisenhardt (1989), shareholders are risk- neutral, because they are able to diversify their risk by managing shares in portfolios. However, CEOs cannot diversify risk and are therefore risk averse. According to Fama & Jensen (1983), these agency problems arise because contracts are costly to write and to enforce. To conclude, manipulating earnings is in the interest of CEOs and not in the interest of the shareholder (who wants to gather useful financial information in order to make good investing decisions). Therefore, earnings management could be explained by the agency theory.
2.2 Social dominance CEO
Social dominance of the CEO is a difficult issue, according to Barclift (2011), because “by the time the problem manifests, it is often after the fraud, illegal activity, or mismanagement has caused harm to the corporation and its shareholders”. The CEO has a lot of power, which is described by Barclift (2011) as ‘the influence in corporate ranks and the influence over the board of directors’ (and thus the audit committee). This is caused by the fact that the board of directors is often appointed from within the informal social networks of CEOs (Finkelstein & Hambrick, 1996; Beasly et al., 2009). When the CEO is involved in the nomination, audit committees are less able to monitor management (Carcello et al., 2011). Due to a lack of monitoring possibilities, earnings management could arise. This means the CEO could play an important role concerning earnings management.
Chen et al. (2015) argue that the variance in earnings management and board independence could result from CEO characteristics. Therefore, this thesis is built upon literature from social psychology, to take the social, cognitive and motivation process that leads to intergroup perceptions into account. In this research, social dominance is described as a personality trait associated with behaviour in an assertive, task oriented, self-confident way, for which ambition and a desire for status in interpersonal interaction are crucial (Gough, 1987). Another description of the trait dominance reflects “a person’s characteristic feelings of control and influence over his life circumstances” (Mehrabian, 1996, p. 266). In other words, individuals who have dominating personalities like to have authority over others (Assor, 1988). According to Pick (2005), the result of the monitor function of the board (in this case particular the audit committee) in order to evaluate the performance of the CEO may strongly influence the role of the CEO.
Anderson & Kilduff (2009) argue that individuals who are more dominant appear to have a lot of influence in groups. So, when a CEO has a dominant personality, he or she will have a lot of influence in face-to-face groups, such as the audit committee. Pick (2005) argued that social influence in groups is a very important factor in predicting the behaviour of (non) members of the group. Dominant individuals often suffer from overconfidence (Langevoort, 2004) and reach influence by acting in ways that make them appear competent (even when they lack competence in reality) in order to take charge of groups (Anderson & Kilduff, 2009). CEOs can influence audit committee members in different ways. On the one hand, they can influence them with non verbal behaviour (Barclift, 2011) and, on the other hand, they can influence them by speaking more, having control over group processes and being
involved in group decisions in a social way (Judge et al., 2002; Anderson & Kilduff, 2009). A dominant CEO is able to change the behaviour, thoughts and feelings of members of the audit committee. However, SOX regards the members of the audit committee to still be independent because they do not have any financial or family ties to the CEO or the company (Bruynseels & Cardinaels, 2013). In reality, the audit committee is not independent anymore, because of the substantial influence of the CEO. Vance (1983) states that when a CEO is socially dominant, it will be difficult for the audit committee to provide effective oversight over managerial decisions and activities. Beasley et al. (2009) argue that some audit committees only play a ceremonial role, instead of a monitoring one. Cohen et al. (2008a) state that the audit committee is ‘relatively passive and ritualistic and ask non- confrontational questions about management actions’. Due to poor monitoring, the CEO is able to conduct earnings management in order to fulfil his or her own goals and interest. For this reason, this thesis predicts a positive relationship between the extent of social dominance of the CEO and earnings management.
H1: A higher extent of social dominance of the CEO results in more earnings management
2.3 Audit committee
The board, and in particular the audit committee, plays a prominent role for constraining the possibility for managers to manipulate earnings in order to fulfil their own interests. The audit committee is an important part of corporate governance and is seen as a source of improvement in governance structures (Ghafran & O’Sullivan, 2013). According to DeZoort et al. (2002), an effective audit committee is able to act as an essential governance mechanism in reducing aggressive financial reporting by management. One of the most important aims of corporate governance reforms worldwide is more transparency (OECD, 1999). The role of audit committee is to oversee the financial reporting process of the firm1 in order to decrease information asymmetries between managers and stakeholders (Klein, 2002). According to Kim & Yoon (2008), transparent financial reporting will lead to an increase in investor confidence, which, because of the recent scandals, is very low nowadays (Bruynseels & Cardinaels, 2013). Members of an audit committee frequently meet with the internal financial managers of the firm and outside auditors, in order to review the financial statements, audit process, and internal accounting controls (Klein, 2002). The SOX of 2002 requires all members of the audit committee to be independent in order to conduct their job effectively.
1
The SOX regards members of an audit committee to be independent when the members do not have any financial or family ties to the CEO or the company itself (Bruynseels & Cardinaels, 2013). Ghafran & O’Sullivan (2013) argue that there seems to be a consensus that more independent audit committees have a positive impact on the quality of financial statements. Previous research argues that corporate governance arrangements could reduce earnings management (Klein, 2002; Dechow et al., 1996; Beasley, 1996). Therefore, it is reasonable to expect that the existence of an audit committee can have a negative moderating effect on the relation between the social dominance of the CEO and earnings management.
H2: The existence of an audit committee has a negative influence on the relationship between the social dominance of the CEO and earnings management
2.4 Women in the audit committee
According to ‘Het Financieel Dagblad’, the quota for Dutch firms is 30% and, in 2016, 23,1% of the board of directors was female.2 So, women are still a minority in the board. When there is a minority of women, men are considered to be more influential compared to women (Karpowitz et al., 2012). As mentioned before, people who are socially dominant have a desire for status in interpersonal interaction. According to Carli (2001), dominant behaviour is more congruent with the social role of a man. In addition, they argued that individuals are more tolerant of men who show dominant behaviour in contrast to women (Carli, 2001). Compared to women, men behave more aggressively, both physically and verbally (Eagly & Steffen, 1986). Moreover, there is much more competition between men and they are likely to show risky behaviour (Griskevicius et al., 2012). As a result, men are more often in conflict with each other when they are a majority in the group (Buss & Schmitt, 1993). Stroebe et al. (2016) argue that when men lose these conflicts, their influence in the group decreases. In contrast, women are less influential and are therefore often not involved in the conflict. As a result of this, women gain more power in groups (such as the audit committee) when they do not keep up with the forcing behaviour of men or join the conflict (Stroebe et al., 2016). Therefore, this thesis predicts women to be less susceptible to social dominance than men. Furthermore, Carter et al. (2003) and Klein (2002) found that board independence is essential for boards to ensure that they act in the best interests of shareholders instead of management. Diversity enhances the independence of the board because a variety in gender, ethnicity or
2 https://fd.nl/ondernemen/1165873/aantal-vrouwen-in-de-top-neemt-af
cultural background results in questions that would not be asked by board members with a more traditional background (Srindhi et al., 2011). Hillman et al. (2007) state that female directors enrich discussions and improve board decision-making because they have different experiences compared to men. Sigh et al. (2008) state in their paper that female directors have a lot of board experience in smaller firms and mostly do not have CEO or COO experience. Furthermore, female directors often do not have business related backgrounds, which results in another perspective on the board (Hillman et al., 2002). According to Adams & Ferreira (2009), female directors provide better oversight over managers. Moreover, women on the board have a higher attendance compared to men. Indeed, when there are more women on the board, the attendance behaviour of men will improve (Adams & Ferreira, 2009). The study of Adams & Ferreira (2009) shows that women who are not part of the ‘old boys network’ are a much better fit for the concept of an independent board member. To conclude, findings from prior research suggest that having more women in the board enhances independence and, as a result, the board is better able to monitor top management in the interests of shareholders. Indeed, according to Marrakchi et al. (2001), board independence leads to a decrease in earnings management. Because audit committees are a board sub-committee, especially responsible for monitoring, it is expected that this will work the same way for audit committees as well. In other words, earnings management could be reduced by female representation in the audit committee.
Moreover, Bruns & Merchant (1990) and Shafer (2015) argue earnings management is an ethical issue. According to Merchant & Rockness (1994), earnings management practices raise the most important ethical issues facing the business profession. Apart from the diversity argument, prior literature shows that women show different behaviour than men concerning ethical issues. For example, Khazanchi (1995) states that women behave more ethically at work and are less likely to engage in unethical behaviour to gain financial rewards. In addition, Powell & Ansic (1997) suggest that women are less likely to take risks in financial decisions. Arun et al. (2015) have already found a negative relationship between female directors and earnings management. Therefore, it can be predicted that, when the female representation in the audit committee increases, the relationship between the social dominance of the CEO and earnings management will decrease.
H3: Female representation of the audit committee has a negative influence on the relationship between the social dominance of the CEO and earnings management
3 . METHOD SECTION
3.1 Research setting
In order to examine this research concerning the relationship between the social dominance of the CEO, earnings management and the moderating role of (female representation in) the audit committee, a quantitative research is performed. Previous research argues that it is difficult to gain access to research on boards and they give some possibilities to overcome this obstacle (Leblanc & Schwartz, 2007). The data is gathered from boards of directors at Dutch housing corporations and educational institutes. To reach a high response on the survey, the boards that participated in this research received an evaluation report about the inner working of their board.
3.2 Sample
Veltrop et al. (2015) mentioned that it is hard to research stock listed companies because publicity around director functioning could have influence on share prices and/or could have litigious consequences. Researching these non-profit organisations is a good alternative, because both Dutch housing corporations and educational institutes have a two-tier structure, just like Dutch stock listed companies. This means that the top management team (chaired by the CEO) and the supervisory board are formally separated. Veltrop et al. (2015) argue that the tasks of the outside directors (part of the supervisory board) are similar to tasks of the outside members within the one-tier structure. Therefore, these firms are a good basis for a research in order to examine the relation between social dominance of the CEO and earnings management. The sample consists 128 not-for-profit organisations. However, in order to test hypothesis 3, I only used 95 organisations, because not every organisation from the sample has an audit committee. To reduce the effect of outliers, the data was winsorized before testing.
3.3 Measures
Dependent variable
To measure the dependent variable, earnings management, I collected archival data. In this case it was publicly available information, disclosed in annual reports. Previous research indicates that managers manipulate earnings through accruals, which is due to the fact that this is tougher to locate by outsiders (Dechow et al., 1995; Jones, 1991; Arun et al., 2015). Therefore, similar to DeFond & Park (2001), I have used abnormal working capital accruals
as a proxy for earnings management. AWCAt = WCt – [(WCt-1/St-1) x St] Where:
AWCAt = Abnormal Working Capital Accruals in the current year
WCt = noncash Working Capital in the current year, which is calculated as:
(current assets - cash and short-term investments) - (current liabilities - short-term debt) WCt-1 = Working Capital in last year
St-1= Sales in the last year; and St = Sales in the current year
Table 1. Description of variables Variables Description Dependent variable: AWCA Independent variable: SD_CEO AC_DUMMY GENDER Control variables: FIRM_SIZE ROA AC_SIZE
Abnormal working capital accruals
Social dominance of the CEO Existence of an audit committee % Female on the audit committee
Logarithm of the total assets EBIT divided by total assets
Number of audit committee members
Independent variable
As discussed before, I conducted research to the inner working of boards by using social dominance of the CEO as independent variable. The social dominance of the CEO (SD_CEO)
is measured by a survey. Ten questions where asked to measure this construct. CEOs rated themselves on a 7-point scale (1 = does not describe me, 7 = describes me very well). We included the following items: ‘I try to override other people's achievements’; ‘I try to perform better than others’; ‘I'm quick to correct others’; ‘I put my will to others’; ‘I expect an explanation of others’; ‘I want to keep control over the conversation’; ‘I'm not afraid to criticize’; ‘I doubt someone else’s points’; ‘I write others the law’; ‘I put pressure on people’. Cronbach’s alpha is .812, which indicates that the internal consistency of the questions is good.
Moderator variables
In order to measure the moderators, the existence of an audit committee and the female representation in this committee, I also collected archival data. The representation of women in the audit committee (GENDER) is measured by the percentage of females on the audit committee.
Control variables
In this research, I use control variables in the model that probably affects the dependent variable, earnings management. First, I control for FIRM_SIZE, which is the logarithm of total assets (Hooghiemstra et al., 2016). According to Meek et al. (2007), governance structures of larger firms are better developed, less subject to information asymmetries and, in general, auditors and financial analysts monitor larger firms more often. Moreover, there is more pressure on larger firms to behave in a way society expects from them (DiMaggio & Powell, 1985). Moreover, I use ROA (return on assets) as a control variable, which is equal to the EBIT divided by total assets (Hooghiemstra et al., 2016; Srinidhi et al., 2011; Gavious et al., 2012; Arun et al., 2015). Finally, I use AC_SIZE, which is the number of audit committee members and I use it as a proxy for board effectiveness (Hooghiemstra et al., 2016; Cheng, 2008; Cornett et al., 2008). Jensen (1993) finds that smaller boards could monitor actions of a CEO effective. Therefore, I expect similar to Cornet et al. (2008) better monitoring will result in a reduced level of earnings management. I expect this works the same for audit committees, since these are sub- committees of the board.
Statistical analysis
On the basis of the least-square method, the following model is established:
AWCAt = β0 + β1* SD_CEO + β2* AC_DUMMY + β3* GENDER + β5* FIRM_SIZE + β6* ROA + β7* AC_SIZE + ε
In this model, βi stands for all coefficients and εi is the error. The mentioned variables are explained in table 1.
4 . RESULTS
In this research, the descriptive statistics are not presented. In order to protect the management team, members and the supervisory board members, their answers on the survey have to remain anonymous. For this reason, all values are standardised. As a result of these standardised values, the mean, standard deviation, minimum and maximum are not meaningful (i.e. the mean is always 0 and the standard deviation is always 1) and therefore not included in a table. The number of observations between the variables is not equal; this is caused by the fact that not all information was available in the annual reports to measure AWCA (proxy for earnings management). Apart from that, in four cases there were two CEOs in a single organisation (due to mergers and phasing out one of the two CEOs). To solve this problem, concerning finding a proper measure of earnings management, I used the CEO with the longest tenure. Moreover, not every organisation has an audit committee, which resulted in fewer observations for GENDER (proxy for female representation in the audit committee). Finally, to reduce the effect of outliers on the results, the data was winsorized (+/- 3* SD).
Table 2 provides an overview of correlations between the variables. The highest correlation exists between AC_SIZE and FIRM_SIZE (correlation coefficient of 0,296). Moreover, this relation is significant (p<0.001). Table 3 shows that the highest VIF (6,75) score is lower than 10, so the possibility of multicollinearity can be excluded with reasonable assurance. In other words, it is not likely that two or more variables are strongly correlated. Therefore, all variables can be used in the regression analysis. It is remarkable that no variable is significant, except the control variable FIRM_SIZE and AC_SIZE. FIRM_SIZE is significant in relation to the ROA (p<.001.), AC_SIZE (<.001.) and AWCA (p<.001.). AC_SIZE is significant in relation to AWCA (p<.01.).
Table 2. Correlation matrix Variable 1 2 3 4 1. FIRM_SIZE 2. ROA 3. AC_SIZE 4. SD_CEO 5. AWCA .248*** .296*** .132 -.238*** -.006 -.036 .022 .131 .099** -.045 *p<.05. **p<.01. ***p<.001.
On the base of a regression, a linear causal relationship between the dependent and one or more independent variables could be estimated (Huizing, 2012, p. 246). Table 4 shows that, compared to the other control variables, FIRM_SIZE has the highest standardized beta (-0,322). This means that this independent variable is most crucial in the prediction of the dependent variable AWCA. The ROA is the least crucial variable in the prediction of AWCA, because the standardized beta is the lowest (0,105).
As mentioned before, I expected a positive relationship between the social dominance of the CEO and earnings management (hypothesis 1). Table 4 shows that regression model 2 explains no significant proportion variance. The test magnitude (F=5,998) is significant, which means in this case that the probability of overriding is not more than 10%. Moreover, there is no significant relationship between SD_CEO and AWCA. This means that hypothesis 1 has to be rejected, based on these two-tailed test. In hypothesis 2, I expected a negative moderating effect of the existence of an audit committee on the relationship between the social dominance of the CEO and earnings management. As could be seen in the table, no significant interaction effect is found. Which means that hypothesis 2 can also be rejected. Finally, I expected a negative moderating effect of female representation in the audit committee on the relationship between the social dominance of the CEO and earnings management (hypothesis 3). Here, no significant interaction effect was found as well.
Table 3. Regression results (1.) (2.) (3.) (4.) Control variables FIRM_SIZE -.322*** -.418*** -.425*** .043 ROA .105*** .164* .163 -.059 AC_SIZE .196*** .216 -.002 -.071 Main effects SD_CEO -.012 -.086 -.142 AC_DUMMY .202 GENDER .087 Two-way interactions SD_CEO x AC_DUMMY .108 SD_CEO x GENDER .212 Adjusted R- squared .096 .136 .133 -.03 F- value 36.735*** 5.998*** 4.254 .606 Highest VIF 1.179 1.191 6.756 6.187
*p<.05. **p<.01. ***p<.001. Standardized regression coefficients are reported. The results are based on a two- tailed test
To conclude, no significant relationship is found. A reason for this could be the indirect proxy (abnormal working capital accruals) for earnings management. In order to prove that there is actually a relationship between the social dominance of the CEO and earnings management, I have conducted an additional analysis. I used audit committee task performance as a proxy for earnings management because as described above the audit committee have to monitor management in order to combat earnings management. This construct is measured by four questions: ‘The audit committee maintains extensive contact with external auditors’, ‘The audit committee gathers relevant information to assess the performance of the external auditor’, ‘The audit committee is strongly involved in the choice of reporting policy’ and ‘The audit committee evaluates the risk of management fraud’. Cronbach’s alpha is .812. In the
appendix, the correlation matrix (table 4) and the regression results (table 5) are given. No significant relationship is found between social dominance of the CEO and audit task as proxy for earnings management.
5 . DISCUSSION
5.1 Conclusion
In this research, the relation between social dominance of the CEO and earnings management is examined. This is relevant, because it takes the social processes between the CEO and the board into account, due to the elite nature of boards, had not been done before (Veltrop, 2012; McNulty & Pettigrew, 1991; Pettigrew, 1992). By using unique survey data, I was able to open the black box concerning behaviour in the boardroom. I expected a positive relationship between social dominance of the CEO and earnings management. The reason for this expectation is that socially dominant CEOs have a lot of influence on the audit committee. As a result of this influence, the audit committee remains dependent and is not able to monitor management properly. Opportunities for earnings management will arise. Furthermore, I researched whether this relationship is influenced by the existence of an audit committee and the percentage of female representation on the audit committee. A possible solution for keeping the audit committee independent is increasing diversity in the board. Introducing women in the board could do this. Moreover, compared to women, men are considered to have more influence, which often results in conflicts between men. When this is the case, women could reach more influence in the board and will be less susceptible to social dominance of the CEO. Finally, previous research shows women to be more ethical at work then men. Since earnings management is an ethical issue, this also indicates a negative moderating effect of female representation in the audit committee on the relationship between social dominance of the CEO and earnings management.
The results do not provide support for the expected relationships. No relationship between social dominance of the CEO and earnings management was found. I conducted an additional analysis where I used audit committee task performance as a proxy for earnings management. However, also in this case no relation is found. A reason for this could be that managers do not always behave as opportunistically as presumed by the agency theory. An alternative perspective is the stewardship theory. According to Davis et al. (1997) the stewardship theory “defines situations in which managers are not motivated by individual goals, but rather are
stewards whose motives are aligned with the objectives of their principals”. The owners (investors) who want fair information have no benefit from earnings management. Therefore, following the stewardship theory, managers will not manipulate earnings.
Furthermore, the results show that the existence of an audit committee does not have a significant effect on the above-mentioned relationship. This could be caused by the mandatory nature of an audit committee by SOX. Beasley et al. (2009) argue that the audit committee plays a more ceremonial role. So, perhaps the audit committee does not contribute much in practice and, therefore, the existence might not influence the relationship between the social dominance of the CEO and earnings management.
Moreover, I found that female representation in the audit committee does not play a moderating role on the relationship between social dominance of the CEO and earnings management. This could be explained by the social categorization theory, which takes the relation between self vis-à-vis a group into account and suggests that diversity also has negative aspects. According to Tajfel (1978), this theory presumes that individuals of a group categorise themselves and other members as in- group and out-group members (Tajfel, 1978). Because women are a minority, they could consider themselves dissimilar out- group members. Moreover, they could be considered to be so by other members of the committee. In this case, women do not identify themselves with the group. Ashforth & Mael (1989) use the following definition of group identification: “personally experiencing the successes and failures of the group”. When there is no group identification, there is a weaker monitoring position and probably more opportunities for the CEO to manipulate earnings arises.
5.2 Limitations and implications for further research
To this scientific research, there are some limitations. First, the sample of this research consists of companies, which have a two-tier board. As mentioned before, this means that there is a formal separation between the top management team and the supervisory board. In contrast to this two-tier board, there is no separation in a one-tier board. The question arises whether the findings are also applicable in other countries, which have one-tier boards. However, Veltrop et al. (2015) argue that the tasks of outside directors (part of the supervisory board) are similar to the tasks of the outside members within the one-tier structure. Therefore, I expect no difference between one-tier boards and two-tier boards. In order to confirm this, future research on this topic is required before I could generalise these
results to one-tier boards. Moreover, it would be interesting to extend this research to other countries then the Netherlands, because Han et al. (2010) found that national culture has an influence on earnings management.
Another limitation of this research is that my sample only consists of non-profit organisations (housing corporations and educational institutes). Leone & Van Horn (1999) have stated that “even though the objective function of not-for-profit institutions differs from for-profit institutions, reputation concerns lead CEOs in not-for-profit organizations to engage in earnings management patterns that are similar to those found in for-profit firm”. So, earnings management does play a role in not-for-profit organisations. However, previous literature shows that non-profit boards are larger and in general represented by more women compared to for-profit organisations (Forbes & Milliken, 1999). Moreover, almost all members of these boards are external and it is possible that they feel committed because they share the same goals (Forbes & Milliken, 1999). So, boards of not-for-profit organisations have different characteristics compared to boards of for-profit organisations. Further research could conduct this research with for-profit organisations to elaborate our understanding concerning this relation.
I have argued that audit committees can be seen as diverse when there is female representation in the committees. However, I realise that, despite more gender diversity, boards are still quite homogenous with regard to age, occupation, class and status position. Eventually, this results in “shared mental models, attitudes, beliefs, and experiences that contribute to group cohesion” according to Pick (2005). E.g. audit committees that consist of females are probably not more independent and, therefore, the monitoring position is not enhanced and they are not able to reduce earnings management as a result of this. This gap in literature could be an opportunity for further research.
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APPENDIX Table 4. Correlation matrix Variable 1 2 3 4 1. FIRM_SIZE 2. ROA 3. AC_SIZE 4. SD_CEO 5. AUDIT_TASK .248*** .283*** .136 .226*** -.022 -.036 -.067 .118 .494*** .027 *p<.05. **p<.01. ***p<.001. Table 5. Regression results (1.) (2.) (3.) (4.) Control variables FIRM_SIZE .043 -.041 -.091 -.169 ROA -.078 -.022 -.035 .479 AC_SIZE .482*** .514** -.132 -.037 Main effects SD_CEO .011 .075 -.585 AC_DUMMY .785 GENDER -.662 Two-way interactions SD_CEO x AC_DUMMY -.176 SD_CEO x GENDER .713 Adjusted R- squared .226 .189 .205 -.102 F- value 10.563*** 3.793** 3.066* .723 Highest VIF 1.198 1.226 1.828 4.572
*p<.05. **p<.01. ***p<.001. Standardized regression coefficients are reported. The results are based on a two- tailed test
