Can a Less Independent Board Be More Effective at Monitoring? Evidence from Real Activities Manipulation

• In Event: Doctoral Interchange Session #1 (Thursday afternoon)
  In Paper Session: Doctoral Interchange Session #1 (Thursday Afternoon)

Abstract

While outside directors are more independent from the CEO, and thus generally viewed as being superior monitors of the CEO’s activities, they suffer informational disadvantages relative to inside directors. Real earnings management requires sufficient firm-specific knowledge to detect because it can involve any real decision that deviates from normal business practice. Without sufficient information to identify suboptimal real decisions, the board may be ineffective at constraining real earnings management. We hypothesize that board informativeness plays a more important role, relative to board independence, in effective monitoring of real earnings management. We find empirical evidence consistent with a positive association between board independence and real earnings management. Additional analyses show that as outsiders face greater information processing costs, the disadvantages of outside directors are even more prominent. Using a recent regulatory change as an exogenous shock, we conclude that causality is likely to run from board independence to real earnings management.

Authors

• Zeyun Chen, University of Colorado at Boulder

• Marc Cussatt, University of Colorado at Boulder

• Katherine Ann Gunny, University of Colorado at Boulder