Does Stronger Corporate Governance Lead to Higher Financial Reporting Quality? Evidence from a Regression Discontinuity Analysis of Shareholder-Sponsored Governance Proposals

• In Event: How Managers and Shareholders Affect Financial Reporting Quality

Abstract

We use a regression discontinuity method to analyze the effect on financial reporting quality of shareholder-sponsored governance proposals that pass or fail by a small margin of votes in annual meetings. This empirical strategy allows us to overcome the endogeneity problem of governance mechanisms and provide evidence on the causal effect of governance mechanisms on financial reporting. We find that passing proposals related to boards of directors and, to a lesser extent, executive compensation leads to higher quality of financial reporting. We also find that this positive effect of governance on financial reporting is more pronounced for firms with lower reporting quality prior to the voting and for firms with more growth opportunities. We find no evidence that passing proposals related to anti-takeover provisions affects financial reporting quality. Overall, our findings suggest that governance mechanisms related to board of directors and executive compensation have a positive causal effect on financial reporting quality.

Authors

• Liang Tan, The George Washington University

• Yanfeng Xue, George Washington University

• Yong Yu, The University of Texas at Austin