Title: Monitoring of earnings management by independent directors and the impact of regulation: evidence from the People's Republic of China

Authors: Liona Lai

Addresses: School of Administrative Studies, York University, 4700 Keele Street, Toronto, Ontario M3J 1P3, Canada

Abstract: Alarmed by escalating volatility in international financial markets and the uncovering of numerous accounting scandals, national regulators worldwide responded by introducing new regulations on corporate governance. To shed light on the debate over the merit of such regulations, this study examines the effectiveness of independent directors in constraining earnings management behaviour in the PRC around the time when the Chinese regulators issued a mandate requiring minimum representation of independent directors in listed firms. The results show that while board independence significantly reduces earnings management when adoption of independent directors is voluntary, a higher degree of board independence is not associated with lower earnings management when adoption of independent directors is made mandatory. This suggests that board independence could be effective in monitoring earnings management even in an institutional environment like that of the PRC, but regulation could distort conditions in the market of independent directors, which renders such governance mechanism ineffective.

Keywords: independent directors; earnings management; discretionary accruals; regulation; China; corporate governance; board independence.

DOI: 10.1504/IJAAPE.2011.037724

International Journal of Accounting, Auditing and Performance Evaluation, 2011 Vol.7 No.1/2, pp.6 - 31

Published online: 26 Dec 2010 *

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