Boards, Takeover Protection, and Real Earnings Management
47 Pages Posted: 12 Jun 2013 Last revised: 12 Oct 2014
Date Written: June 11, 2013
Abstract
We investigate the effect of board governance and takeover protection on real earnings management. Four types of real earnings management are considered: sales manipulation, overproduction, the abnormal reduction of research and development (R&D) expenses, and the abnormal reduction of other discretionary expenditures. Using panel data from U.S. public firms in the post-Sarbanes–Oxley Act period, we find that the level of real earnings management (sales manipulation, abnormal declines in R&D expenses, and other discretionary expenses) increases with better board governance and decreases with higher takeover protection. These two governance factors generally have no significant effect on overproduction. We further find that firms substitute accrual-based earnings management with sales manipulation and abnormal cuts in discretionary expenses, and the substitution effect is more pronounced in firms with stronger board governance. Overall, our findings indicate that the level of real earnings management is higher when a firm is faced with tough board monitoring, and that takeover protection may reduce managerial incentives for real earnings management.
Keywords: Corporate governance, Board, Anti-takeover provision, Real earnings management
JEL Classification: M41, G34
Suggested Citation: Suggested Citation