Lebanese American University

Effects of Corporate Governance on Earnings Management:

The Case of Lebanon
By

Lama M. Al-Hafi

A Thesis
Submitted in partial fulfillment of the requirements
for the degree of Master of Business Administration

School of Business
May 2016
 ©
2016
Lama Al-Hafi
All Rights Reserved
 ACKNOWLEDGMENT

Very special thanks of gratitude to my professor and advisor Dr. Walid El Gammal
who was very supportive and understanding throughout the whole process. Of course the
thesis wouldn’t have been completed without the help and guidance of Dr. Abdel Nasser
Kassar and not to forget the assistance of the committee member Dr. Mahmoud Araissi.
Finally, I would like to thank my family and friends for all their love and support.

V
Effects of Corporate Governance on Earnings Management:
The Case of Lebanon

Lama M. Al-Hafi

ABSTRACT

Effects of corporate governance practices on various financial, managerial, and

operational activities within organizations have been extensively studied in the previous
two decades. Earnings management, viewed as legal and appropriate means by some
researchers and illegal by others, is one of the financial activities that could be impacted by
the corporate governance practices of the organization. Higher level of implementation of
the corporate governance components (transparency of financial data, board of directors,
ownership structure, corporate social responsibility and audit committee) is thought to
reduce unfavorable earnings management. Several recent studies have concluded that
Lebanese corporations do not give corporate governance much importance. Moreover,
earnings management has not been tested thoroughly within the Lebanese context. This
study focuses on determining the impact of good corporate governance practices on
reducing unfavorable earnings management activities. In particular, the study aims at
identifying the corporate governance components to reducing unfavorable earnings
management by Lebanese organizations. Data were collected from questionnaires which
were distributed to employees working at various Lebanese companies and having a certain
level of familiarity with their company’s financial reporting. Results show that companies
with higher degree of independence of the board of directors, effective audit committee,
transparency in terms of financial reporting, and good corporate social responsibility
practices tend to have less unfavorable earnings management.

Keywords: Corporate Governance, Transparency of Financial Statements, Ownership

Structure, Board of Directors, Audit Committee, Corporate Social Responsibility, and
Earnings Management Practices.

VI
 TABLE OF CONTENTS

I. Introduction to Corporate Governance & Earnings Management ............................. 1

1.1 Overview and Background ............................................................................................... 1

1.1.1 Corporate Governance ...................................................................................... 1

1.1.2 Earnings Management ....................................................................................... 5

1.2 Purpose of the Study ........................................................................................................ 8

1.3 Research Question ............................................................................................................ 9

1.4 Research Objective........................................................................................................... 9

1.5 Relevance of the Study................................................................................................... 10

1.6 Limitations of the Study ................................................................................................. 10

II. Literature Review ......................................................................................................... 11

2.1 Corporate Governance ................................................................................................... 11

2.1.1 Transparency of Financial Statements ............................................................ 12

2.1.2 Ownership Structure........................................................................................ 14

2.1.3 Board of Directors ........................................................................................... 16

2.1.4 Audit Committee ............................................................................................. 17

2.1.5 Corporate Social Responsibility ...................................................................... 18

VII
2.2 Earnings Management Practices .................................................................................... 21
2.3 Corporate Governance Components and Earnings Management Practices ................... 22

2.3.1 Transparency of Financial Statements and Earnings Management Practices . 22

2.3.2 Ownership Structure and Earnings Management Practices ............................ 23

2.3.3 Board of Directors and Earnings Management Practices ............................... 26

2.3.4 Audit Committee and Earnings Management Practices ................................. 26

2.3.5 Corporate Social Responsibility and Earnings Management Practices .......... 27

2.4 Hypotheses ..................................................................................................................... 28

III. Methodology ................................................................................................................. 29

3.1 Design Analysis ............................................................................................................. 29

3.2 Measurement Techniques............................................................................................... 30

3.3 Sample ............................................................................................................................ 30

3.4 Data Collection............................................................................................................... 31

3.5 Statistical Methods ......................................................................................................... 32

IV. Findings Analysis and Discussion .............................................................................. 33

4.1 Descriptive Statistics ...................................................................................................... 33

4.1.1 Size of Company ............................................................................................. 33

4.1.2 Years of Experience ........................................................................................ 35

VIII
 4.13 Board of Directors Size.....................................................................................................36

4.1.4 Board of Directors Meetings..........................................................................................38

4.1.5 Sales.......................................................................................................................................39

4.1.6 Annual Sales over the Last 5 Years...............................................................................40

4.1.7 Debt........................................................................................................................................42

4.2 Reliability Analysis..............................................................................................................................43

4.3 Correlation Analysis............................................................................................................................44

4.4 ANOVA...................................................................................................................................................48

4.4.1 Size and Earnings Management Incentives................................................................48

4.4.2 Years of Experience and Earnings Management Incentives.................................49

4.4.3 Board of Directors Size and Earnings Management Incentives..........................50

4.4.4 Sales and Earnings Management Incentives..............................................................51

4.4.5 Difference in Sales and Earnings Management Incentives...................................52

4.4.6 Debt and Earnings Management Incentives...............................................................53

4.4.7 Size and Earnings Management Tools.........................................................................54

4.4.8 Years of Experience and Earnings Management Tools...........................................55

4.4.9 Board of Directors Size and Earnings Management Tools....................................56

IX
 4.4.10 Sales and Earnings Management Tools ........................................................ 57
4.4.11 Difference in Sales and Earnings Management Tools .................................. 58

4.4.12 Debt and Earnings Management Tools ......................................................... 59

V. Conclusion ...................................................................................................................... 61

5.1 Summary ............................................................................................................61

5.2 Conclusion and Recommendations .................................................................... 62

5.3 Future Research .................................................................................................. 63

VI. References ..................................................................................................................... 64

Appendix “A” ..................................................................................................................... 77

X
 LIST OF FIGURES

Figure 1: Average Size of Companies with respect to Number of Employees.........................34

Figure 2: Average of Years of Experience for the Companies.......................................................35

Figure 3: Average Board Size..................................................................................................................37

Figure 4: Average Meetings of the Board of Directors....................................................................38

Figure 5: Average Sales.............................................................................................................................39

Figure 6: Average Annual Sales over the Last 5 Years....................................................................41

Figure 7: Average Debt..............................................................................................................................42

XI
 LIST OF TABLES

Table 1: Average Size of Companies with respect to Number of Employees...........................33

Table 2: Average of Years of Experience for the Companies.........................................................35

Table 3: Average board Size.....................................................................................................................36

Table 4: Average Meetings of the Board of Directors......................................................................38

Table 5: Average Sales...............................................................................................................................39

Table 6: Average Annual Sales over the Last 5 Years......................................................................40

Table 7: Average Debt................................................................................................................................42

Table 8: Cronbach’s Alpha of CG and EM Components................................................................43

Table 9: Correlation Matrix......................................................................................................................44

Table 10: Comparison of Means between the Size of the Company and EM Incentives......48

Table 11: One-way ANOVA for the Size of the Company and EM Incentives........................48

Table 12: Comparison of Means between Years of Experience and EM Incentives...............49

Table 13: One-way ANOVA of Years of Experience and EM Incentives..................................49

Table 14: Comparison of Means between the BOD Size and EM Incentives..........................50

Table 15: One-way ANOVA for the BOD Size and EM Incentives............................................50

Table 16: Comparison of Means between Sales and EM Incentives...........................................51

XII
Table 17: One-way ANOVA for Sales and EM Incentives.............................................................51

Table 18: Comparison of Means between Difference in Sales and EM Incentives................52

Table 19: One-way ANOVA for the Difference in Sales and EM Incentives...........................52

Table 20: Comparison of Means between Debt and EM Incentives............................................53

Table 21: One-way ANOVA for Debt and EM Incentives..............................................................53

Table 22: Comparison of Means between Size of the Company and EM Tools......................54

Table 23: One-way ANOVA for the Size of the Company and EM Tools.................................54

Table 24: Comparison of Means between Years of Experience and EM Tools........................55

Table 25: One-way ANOVA for Years of Experience and EM Tools..........................................55

Table 26: Comparison of Means between the BOD Size and EM Tools....................................56

Table 27: One-way ANOVA for the BOD Size and EM Tools......................................................56

Table 28: Comparison of Means between Sales and EM Tools....................................................57

Table 29: One-way ANOVA for Sales and EM Tools......................................................................57

Table 30: Comparison of Means between the Difference in Sales and EM Tools...................58

Table 31: One-way ANOVA for the Difference of Sales and EM Tools....................................58

Table 32: Comparison of Means between Debt and EM Tools.....................................................59

Table 33: One-way ANOVA for Debt and EM Tools.......................................................................59

XIII
 LIST OF ABBREVIATIONS

BOD: Board of Directors

CG: Corporate Governance

CSR: Corporate Social Responsibility

EM: Earnings Management

MENA: Middle East and North Africa

OECD: Organizations for Economic Cooperation and Development

XIV
 Chapter I

INTRODUCTION TO CORPORATE GOVERNANCE

& EARNINGS MANAGEMENT

This chapter includes the overview and background of corporate governance and

earnings management, the need for undertaking this study, the research problem aimed to

be investigated, the research objectives, the relevance of this study, and finally the

limitations.

1.1 Overview and Background

In this section, a general summary of corporate governance functions will be

presented as well as an overview about earnings management practices.

1.1.1 Corporate Governance

Corporate governance within the last twenty-five years has become one of the

highly inquired studies in the business field. It frames and controls all the rules and

regulations that must be followed by all the firm’s participants. After the World War II, the

United States exhibited the emergence of the high-status class. This class led to the

expansion of corporations quickly without adequate accountability or control from the

board of directors which resulted in several bankruptcies. Thus, the importance of corporate

governance appeared, and over the past eras it has been expanding enormously in the U.S

and other countries.

1
 In the 1980s, the main purpose of applying corporate governance was focusing on

arranging constitutional mechanisms for preventing managers, as much as possible, from

serving their own interest (Khongmalai, Tang, & Siengthai, 2009). The board of directors

played a major role in the internal governance of an organization by harmonizing the

interests of owners and managers (O’Regan, O’Donnel, Kennedy, Bobtis, & Cleary, 2005).

Moreover, the increasing difficulty of the challenging situations that are facing firms drove

organizational practitioners and academicians to widen the corporate governance function.

As a result, corporate governance functions have broadened to include not only monitoring

and controlling, but also intensifying strategic plans and assuring the reliability of

management procedures (Michie & Oughton, 2001).

Afterwards in 2007, the economic and financial crisis took place and created chaos

on the level of the banking sector worldwide; it mostly affected the United Kingdom and

the United States which are the world's leaders financially (Bruner, 2011). The capitals,

London and New York, were in the center of the catastrophe in which their banks were

harmed enormously through the high levels of losses and obligations on the mortgage

securities. At the end of the crisis and the beginning of a new phase, both nations embraced

several regulatory and instructive efforts to prevent such crises from reoccurring, and one

of these efforts were corporate governance modification. This modification is needed to

provide shareholders with more power to restrain irresponsible managers in the future in all

types of organizations not only financial ones (Bruner, 2011).

Both countries used almost the same approaches toward the catastrophe in which

they gave more authority to the shareholders. However, the U.K and U.S corporate

governance structures significantly differ on some basic issues where the U.K structure

stressed much more attention to the shareholders than the U.S structure. This means that

2
U.K system is more shareholder-oriented than the U.S system (Bruner, 2011). In general,

the concept of corporate governance is the same in any country, but it is modified with

respect to different circumstances that occur in each country.

In fact, scholars and governments accepted the idea that corporate governance

systems affect the firm's performance and long-standing values (Nelson, 2005). The agency

theory is the theory that stimulates the functions of corporate governance (Baker & Owsen,

2002). Because the owners are no longer in charge of control, a probable authority problem

developed into the corporate system and this is the idea behind the theory. Agency conflicts

occur when the managers, who are recruited to take decisions for the shareholders'

maximum benefits, are taking decisions that best suit their own position or interest

(Khongmalai et al., 2009).

According to Dima, Ionesscu, and Tudoreanu (2013), corporate governance has

established an idea that is associated with the management and the system of an

organization. Therefore, corporate governance, originally, was seen as a structure that

monitors and controls firms. Besides, corporate governance is considered to be the system

that focuses on the distribution of tasks and rights among stakeholders (Organizations for

Economic Cooperation and Development, 2004). In addition, corporate governance is

viewed as the administration and regulation procedures that are implemented by the firm.

Also, it is defined as the key factor to enhance the financial and economic development,

and provide more confidence to investors (Yassin, Ghanem, & Rustom). In general,

corporate governance is a well-structured system that is established to control the

organization through achieving long-term objectives, complying with rules and regulations,

governing management practices and financial reports, and meeting the environmental

needs. Furthermore, effective corporate governance should include specific characteristics:

3
transparency, accountability, responsibility, transparency in the organization’s activities and

structures, accountability of the management, audit committee, and board of directors, and

responsibility of the firm toward its investors.

In Lebanon, according to the World Bank in 2003 addressing on the Corporate

Governance in the MENA region, indicated that corporate governance is not that

productive with respect to other countries in the Middle East and North Africa. Signifying

that Lebanon is less effective considering public responsibility, data disclosure, and overall

governance (Elgammal, Assad, and Jurdy, 2014). However, the Lebanese banking sector

was able to relocate itself regarding the efficiency of corporate governance by applying the

modern international principles, and implementing regulations that guarantee its reliability

(Elgammal et al., 2014). Yet, other sectors in Lebanon still consider that corporate

governance is not of a great importance. This is due to believing that Beirut Stock trade has

a limited number of small to medium firms whose stocks are not broadly traded (Elgammal

et al., 2014).

In general, many challenges are faced by corporate governance like globalization

and technology progress (Fadun, 2013). Consequently, in the climate of dynamic and

macro-environment changes, effective corporate governance must assist in the efficient

organization's management. Additionally, because of less governmental monitoring and

rules, effective corporate governance recognizes the need and importance for accountability

and keeps records of all activities engaged as an evidence of its transparency. Effective

corporate governance encourages economic expansion and improvement (Fadun, 2013). An

effective corporate governance can be measured according to the transparency of financial

statements, the structure of ownership, the

4
effectiveness of board of directors, the usefulness of audit committee, and the appliance of

corporate social responsibility.

One of the many issues that corporate governance handles is earnings management.

In the last few years, corporate earnings management has been standing out among the

most widely examined parts in finance and financial accounting (Matsuura, 2008). By

managing earnings, managers hide the real earnings and financial position of the

organization (Matsuura, 2008).

1.1.2 Earnings Management

Earnings management is a strategy used to keep a stable image of the firm’s

earnings. “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 influence contractual outcomes that

depend on reported accounting numbers” (Healy & Wahlen, 1999).

According to FASB (1985), the nature of accrual accounting “attempts to record the

financial effects on an entity of transactions and other events and circumstances that have

cash consequences for the entity in the periods in which those transactions, events, and

consequences occur rather than only in the period in which cash is received or paid by the

entity” (Abu Siam, Binti Laili, & Bin Khairi, 2014). This provides managers a substantial

amount of discretion in recognizing the actual earnings an organization reports in any given

time (Abu Siam et al., 2014).

As a matter of fact, earnings management can be separated into accounting and

real. Accounting earnings management are decisions taken by managers and are accepted

under the Generally Accepted Accounting Principles (GAAP), like converting the

5
inventory estimation method from FIFO to LIFO or vice versa, and changing from straight

line depreciation method to double declining depreciation method. However, real earnings

management are decisions related to actual investments and production, like decreasing the

research and development expenses and administrative expenses (Matsuura, 2008).

Some consider these practices as illegal acts while others consider them legal.

Those who view them as illegal acts believe that managers intentionally manipulate the

organization’s earnings to maintain an image that meets the prearranged goals. Therefore,

to increase the number of investors in the firm, management deceives them by structuring

transactions to keep the annual financial reports stable instead of having years of satisfying

or dissatisfying balances. However, those who think these practices are legal believe that

the company is adopting an added-value activity. Earnings management is perceived as a

tool that guides management in allocating resources. It will increase the company’s value

without manipulating financial statements and at the same time it doesn’t reflect the

economic reality in any way. In addition, current accounting system contains some options

that permit management to manage earnings. In general, managers can use these options to

reach their objectives, and as long as they are using them within the borders of GAAP,

earnings management is considered legal (Matsuura, 2008).

According to Abu Siam et al. (2014), internal and external members of any business

depend on the financial statements that are supposed to deliver accurate and valuable data.

Also, the efficiency of the market depends on the data which flow to capital markets. When

earnings management occur and misleading data exit, the market will not be able to value

securities appropriately. Therefore, earnings management can misrepresent the real

performance of the organization and reduce the creditors’ and shareholders’ ability to make

the right decisions (Abu Siam et al., 2014). Subsequently, the real question is can

6
earnings quality be trusted? This question is mainly asked by both creditors and regulators

who ask for accurate ways to prevent factors that are possibly the reason behind misleading

earnings. For example, one of these factors is managerial discretion which is mostly

spotted. It mainly happens if the relationship between the agent and the principal is

influenced due to some inadequacies, or if the corporate governance implementations are

not availed. Many recent studies on earnings quality revealed that when managerial

discretion occurs, the organization’s real economic performance is lost (Jouber &

Fakhfakh, 2011). In addition, many studied the factors and constraints that affect earnings

management. They found that the audit quality is a major constraint on the magnitude of

earnings management (Becker, DeFond, Jiambalvo, & Subramanyam, 1998). The

destruction of creditors’ certainty in the quality of financial reports, and the obstruction of

the effectual movement of capital in the financial market result from the practice of

earnings management (Jackson & Pitman, 2001). Therefore, in order to detect and limit

earnings management, audit companies must distinguish themselves through specialization

for example (Watkins, Hillison, & Morecroft, 2004). Specialization allows the auditor to

deliver wider services and credibility; thus, the auditor will be able to find techniques for a

more effective auditing process and improve the ability to detect and limit earnings

management (Beasley & Petroni, 2001).

Why do managers record accruals? Mainly there are two motivations that make

managers record accruals: performances/signaling reasons and opportunistic earnings

management. Performance/signaling reasons means when managers want to show a better

organizational economic performance, they record accruals. While the opportunistic

earnings management is when managers hide bad performance or delay the recognition of

good performance for them to maximize their effectiveness. As a result, when

7
shareholders notice that earnings management is opportunistic, they reduce the accounting

numbers created by the organization’s management (Habib, 2004).

Therefore, agency theory is considered a core reason behind earnings management

practices (Richardson, 2000). The conflict that occurs between managers and shareholders

urges for the separation between ownership and management (Khalil, 2010). This is due to

the complete independence from managers when it comes to accounting decisions which

gives them the authority to make selections and implement a scope of practices that may

refute the owner’s interests leading to earnings management practices (Khalil, 2010).

The aim of this research is to study the relation between corporate governance and

earnings management, and to what extent the former influence the latter.

1.2 Purpose of the Study

As mentioned earlier, the main purpose of this research is to determine the effect of

corporate governance on earnings management practices. Several researches were

conducted to study the relationship of corporate governance and its impact on the limitation

of earnings management. In their study, Chtourou, Bedard, and Courteau (2001), stated that

effective corporate governance limits earnings management activities. In addition, the

experience of the board of directors seems to decrease earnings management practices.

According to Findlay (2006), an independent board of directors must be endorsed for the

company to be more productive in monitoring the discretionary judgment of the

management. In addition, according to a study done in Thailand, the board of directors that

carries out several directional situations, has a greater experience,

8
knowledge, and skills in monitoring tasks than the one that handle only one firm’s board

(Sukeecheep, Yarram & Al Farooque, 2013).

After assuming the relation between the components of corporate governance with

earnings management, several examinations must be done to test the effect of corporate

governance on earnings management practices. Finally, some recommendations must be

suggested for future studies.

1.3 Research Question

In this section, the researcher tries to examine if there is a relationship between the

transparency of financial statements , ownership structure, board of directors, audit

committee and corporate social responsibility (corporate governance components) and

earnings management practices. In other words, the researcher tries to answer a very

important question which is how corporate governance components and earnings

management practices are related.

1.4 Research Objective

Since corporate governance and earnings management have recently become the

center of attention for all businesses, we studied the relation between these two matters. In

addition, according to the latest studies, developing nations are in need for well advanced

corporate governance. Therefore, this examination was done to test the corporate

governance and its influence on earnings management in Lebanese companies. In this

study, the effects of corporate governance on earnings management practices are studied in

general. Then, some of the corporate governance components are examined to find their

relation with earnings management.

9
 The aim is to see which component of corporate governance, whether the

transparency of financial statements, the ownership structure, the board of directors, the

audit committee, or the corporate social responsibility lower(s) the likelihood of earnings

management practices. Thus, the relationship between these components and earnings

management will be tackled thoroughly. Finally, earnings management incentives are added

to see their effect on the relationship of the corporate governance components and earnings

management practices.

1.5 Relevance of the Study

The study upon its completion will reveal the relationship between the above

components of the corporate governance and earnings management practices. Furthermore,

it will show the influence of the incentives of earnings management on the practices of

earnings management. Moreover, it will show how the application of corporate governance

by corporations in a developing country like Lebanon impacts the practices of earnings

management.

1.6 Limitations of the Study

The survey sought the view of different employment levels in which every

employee’s answer was a perspective of different sections; thus there wasn’t much interest

in the study. This was one of the limitations. Moreover, due to time limitation and

deadlines, the surveyed employees were all within the campus of the Lebanese American

University (LAU), Beirut.

10
 The aim of this research is to study the relation between corporate governance and

earnings management, and to what extent does the former influence the latter. The

following section presents a view about previous studies done about the topic.

11
 Chapter II

LITERATURE REVIEW

In this chapter of the study, the prior researches and the hypotheses are presented.

The first section discusses the corporate governance including its components

(transparency of financial statements, ownership structure, board of directors, audit

committee, and corporate social responsibility). The second section discusses the earnings

management practices. The third section links between the corporate governance

performance and earnings management practices. The last section states the hypotheses that

are tested.

2.1 Corporate Governance

Certainly, corporate policies are to a large scope responsible for the business

performance, but the extent of earnings management depends more on the operating

performance (Chung, Firth, & Kim, 2005). In addition, corporate governance policies offer

conditions that might be satisfactory for earnings management like “opportunistic behavior,

a culture of self-fulfillment that prizes short-term gains at the expense of long-term stability

and habits of selective and subjective disclosure, etc.”, or unsatisfactory like

“ a culture encouraging transparency, integrity and accountability” (El Mehdi & Seboui,

2011).

Corporate governance is the framework by which corporations are organized and

ruled (Adiloglu & Vuran, 2012). Its main concern is generally with the ways organizations

are ruled and specifically with the relation between the owners of the corporation and its

12
managers. Recently, the effects of corporate governance on the organization’s performance

have kept on increasing across the board conspicuousness in the capital market economy

sector (Adiloglu & Vuran, 2012). The stakeholder’s expectations regarding corporate

governance performance have never been that high, and the examination done by investors

and controllers has never been that strict (Adiloglu & Vuran, 2012). As a result, the scrutiny

has not only been limited to the corporate governance performance in general but also it

included transparency of financial statements, ownership structure, board of directors, audit

committee, and corporate social responsibility.

2.1.1 Transparency of Financial Statements

Transparency in reporting all financial transactions and disclosures have always

been a requirement that assures the honesty and credibility of any company. For long term

survival, transparency is very essential in any business. Capital market depends on

corporate governance to secure the transparency of financial statements (Fung, 2014).

Transparency of financial reports means that all financial data and transactions must be

conveyed regardless of its assessment. In addition, transparency in financial statements

occurs when all stakeholders have the ability to access all the needed information to value

financial institutes on a timely basis (Vishwanath & Kaufmann, 2001).

Transparency is noticeably related to the topic of governance reformulation, in

which it represents a fundamental value of corporate governance (Adiloglu & Vuran,

2012). Also, in the corporate governance guiding principles of the Organization for

Economic Cooperation and Development (OECD), transparency presents a primary

foundation where the shareholder’s assurance and the market efficiency rely on the

disclosure of correct time data about the performance of the corporation. The company’s

13
stakeholders will stay up-to-date about all the techniques used to govern and manage a

company in a transparent atmosphere (Healy & Palepu, 2001).

Several activities and procedures lead to an off-balance sheet item resulting in a

decrease in the transparency of financial statements. Investments in the equity of other

companies, transfers of financial assets, retirement procedures, leases, and conditional

debts and guarantees are all examples of actions that lessen the transparency of financial

reporting (Lander & Auger, 2008). As a result, consecutive let-downs of several

corporations like Adelphia and WorldCom showed a real failure in the corporate

governance system, auditing procedure, and financial reporting practices. Sarbanes-Oxley

Act of 2002 aroused due to huge efforts that were exerted to regain the citizens’ confidence

in the American business, the accounting profession, and the stock market. (Lander &

Auger, 2008). The main aim behind Sarbanes Act is to increase transparency in the

financial reporting and accounting.

According to Ştefănescu and Ţurlea (2014), transparency is a way of action or an

attitude of confident leaders who make all their actions public and recognized permanently.

Transparency is a wide flow of information. Transparency overcomes ethics in which

everything must be reported to the public to ensure effective governance (Ball, 2009).

Transparency and ethical values are associated because of the fact that they assure all the

population of the quality of services offered, and satisfy the population needs (Holzner &

Holzner, 2006).

It is important to note that one of the reasons behind the subprime crisis in 2008

was the absence of transparency of the data in the financial market (Mendonca, Galva˜o, &

Loures, 2010). Furthermore, these data are considered important since they are to some

extent related element to the market discipline. Likewise, a tool for observing financial

14
organizations is the viable transparency in the data revealed to the private operators

(Flannery, 1998). Also, transparency of data to the market permits the private operators to

examine the main information on investments, assessment process, and risk exposure

(Mendonca et al., 2010).

2.1.2 Ownership Structure

Ownership structure of a firm is the distribution of equity according to the capital

and votes. This structure is very essential for corporate governance because it decides on

the incentives that must be given to managers who will direct the firm's financial

efficiency.

The perception of ownership structure is a core concept within the wide range of

corporate governance. Actually, ownership structure is considered a tool of corporate

governance. Berle and Means in 1932 argued that in modern corporations, management

motivation to maximize organization’s productivity decreases through the separation of

ownership and control (Hu & Izumida, 2008).

Ownership is considered a power that is supported socially in a way that gives it the

authority to control something that is completely owned and employed for personal

purposes (Henryani & Kusumastuti, 2013). However, ownership structure is considered as

the different patterns and systems of ownership that are present in a firm or the amount of

stocks owned by inside and outside shareholders (Jensen & Meckling, 1976). Furthermore,

ownership structure is important to show essential variables in the capital structure. They

are determined by the percentage amount of shares owned by internal and external

shareholders not only by the amount of debts and equity (Xu & Yan, 1999).

15
 There are several sorts of ownership structures: public ownership, government

ownership, managerial ownership, institutional ownership, and ownership which is a

combination of all. Public ownership is the shares owned by the government in an

organization. Public ownership has a crucial role in forming an effective government

system functions because it acts independently when it comes to management assessment

(Jensen, 1993). As a regulator, the government is responsible to govern individuals and

make sure that the firm is operating under a corporation management to look over its

stakeholders mainly the investors (Henryani & Kusumastuti, 2013). Government is the

superior controller in organizations that it owns and are well-known as the State Owned

Corporations. Companies owned by the government are less independent than those that

are not because their main aim is to stay in collaboration with the country’s well-being

(Henryani & Kusumastuti, 2013).

The most significant types of ownership are the managerial and institutional. The

agency conflict occurs between managers who represent shareholders and shareholders or

investors who are the principal of the organization. Agency conflict explains the presence

of managerial ownership structure (Henryani & Kusumastuti, 2013). Agency problems

lower the value of any corporation. An increase in the managerial ownership creates an

essential incentive that encourages managers to act on the behalf of the shareholders and

maximize the share’s price (Warfield, Wild, & Wild, 1995). Managerial ownership is a

share ownership controlled by the board of directors, employees, managers and the

company’s other internal devices. Unlike managerial ownership which focuses on the

personal owners, institutional ownership focuses on the institution itself (Henryani &

Kusumastuti, 2013). It refers to the shares that are owned by other large financial

16
corporations. In general, companies buy large lumps of a corporation’s shares in order to

have control on the management.

2.1.3 Board of Directors

The board of directors is the elected members that supervise all the activities of the

organization. The board of directors as the highest authority in an organization which exerts

a great influence on the firm’s performance. As a result, all activities and transactions are

influenced by the board's sovereignty. The board’s main aim is to act for the favor of all

shareholders. The board represents the shareholders in the firm and strives to make the

greatest outcome of the corporation’s activities (Argandona & Ayuso, 2009).

The board of directors plays an important role in controlling and supervising an

organization’s management to assure that the managers are working for the shareholders’

benefits (Abu Siam et al., 2014). Thus, the board of directors has an essential job when it

comes to monitoring and regulating the quality and consistency of financial statements

(Beasley, 1996). In addition, the board ensures the disclosures of financial reports and the

operating outcomes of the firm are being provided to all stakeholders including all

shareholders. This is a significant responsibility that has been delegated to the board of

directors in order to govern. As a result, the supervision of the board on all financial

statements is very important because managers have the tendency to manage earnings and

possibly mislead investors (Abu Siam et al., 2014).

In relation to the board of directors, one can consider several characteristics like the

independence, size, meeting, etc…This study focuses on the independence and

effectiveness of the board of directors. Outside directors dominate the board, and they must

be independent and separated from the management. Many studies found that as the

17
independence and effectiveness of board of directors increases, the organization's

performance improves (Agrawal & Knoeber, 1996; Baysinger & Butler, 1985).Sustaining

independent members in the board of directors can accomplish the principles of a righteous

effective corporate governance (“King Report on Corporate Governance,” 2002). Thus, the

independence of directors leads to more effectiveness in to controlling the activities of the

organization (Bhagat & Black, 2001). Moreover, all meetings must be planned and

arranged by the board’s members directly; specifically when the situation needs immediate

movement and regulation (Shivdasani & Zenner, 2004). In order to monitor the firm’s

performance constantly, the board’s members should meet at least one to four times yearly

(“King Report on Corporate Governance,” 2002).

2.1.4 Audit Committee

Audit committee is one of the crucial components of corporate governance since it

plays an important role in ratifying it (Badara & Saidin, 2013). It includes specialists of

different parts in a firm for self-governing purposes. Auditing committee is an operating

group of the board of directors responsible for the supervision of financial reports and

disclosures. In fact, audit committee improves the quality of auditing at two levels (Piot &

Janin, 2007). First, the committee reduces or limits the use of earnings management

activities by monitoring the performance of the accounting department. Second, any

indiscretion in the financial statements or disclosures will more likely be revealed due to

the committee assortment between the internal and external auditors, and its protection for

the sovereignty of external auditors (McMullen, 1996).

Members of auditing committee are in charge of many responsibilities like the

reliability of financial statements, the effectiveness of internal audit and external audit, and
18
the prevention of any prohibited actions (El-Kassar, Elgammal, and Bayoud, 2014).

Moreover, the Sarbanes-Oxley Act (2002) defines audit committee as a group of

individuals that are selected by the board of directors to oversee all accounting and

financial information. Nowadays, the role of audit committee in controlling the auditing

process has become more traceable and difficult. Thus, it is known as the most reliable

patrol in any business (Levitt, 2000). In addition, the audit committee task as mentioned in

the Lebanese Code of Corporate Governance in 2006, is to design and asses the

organization’s financial statements and data. Further, it supervises the financial reports

done by the internal audit. It also makes a meticulous yearly report that is revised by the

board of directors beforehand of the addition to the organization’s annual report (Lebanese

Code of Corporate Governance, 2006).

Several studies were conducted to assess the effectiveness of the audit committee

when working as a team with the internal audit. It is important to note that the audit

committee has the greater power when assessing the internal audit responsibilities and

hiring the best person for directing the internal auditing (Davies, 2009). Also, audit

committee must provide guidelines for the internal audit to perform its tasks and achieve

enhancement in all of its functions (Karamanou & Vafeas, 2005). It is as well responsible

for sustaining the independence of the internal audit (Goodwin & Yeo, 2001).

2.1.5 Corporate Social Responsibility

Corporate social responsibility (CSR) is a new concept to business. Being

compliant with the laws, norms, and ethics improve the quality of life of all creatures.

Since it has been an important issue in the last few years, and it affects the organizations

19
performance as a whole, a study has been conducted to examine the relation between

corporate social responsibility and earnings management.

Corporate social responsibility has attained notice in the last few years from several

industrial entities. CSR has become a requirement for all organizations, not only for large

ones. It assists firms to stay in compliance with all norms, laws, and ethics to ameliorate the

human’s welfare. According to Kim, Park, and Wier (2011), CSR proponents believe that

all entities should carry out social practices for stakeholders’ advantage. Also, CSR isn’t

considered a waste of the company’s scarce resources; however, it is viewed as an

important constituent that contributes in creating value for all stakeholders (El-Kassar,

Messarra, & Elgammal, 2015). Moreover, CSR supporters assume that firms are

materialistic prospectors that don’t initiate any social activity unless they get pressured; this

is typical in underprivileged countries.

According to an editor in the Canadian Financial Post magazine, corporations must

always make sure that their practices agree with all the standards and rules of CSR strategy

that is applied by the Canadian government (Hassselback, 2014). Applying CSR activities

are considered easy to huge organizations, because they have all the resources needed to be

socially responsible unlike the case of small corporations. Corporate social responsibility is

when the business act with conscious and all corporations should be socially active for

them to survive (Legg’s, 2014). In addition, Gainer (2010) referred to social responsibility

as “movements” that define a custom of ideas and thoughts about business practices in

which promoters encourage their implementation by corporations. Through engaging social

practices, organizations possess positive behavior from their stakeholders, make strong

relations with them, and build a respectable image for the business (Du, Bhattacharya, &

Sen, 2010).

20
 Moreover, corporate social responsibility is a strategic assessment where an

organization has an obligation towards the society. This obligation includes many

responsibilities within and outside the firm. Obligations within the organization consist of

all commitments towards employees like providing fringe benefits, paying wages and

paying transportation. Obligations carried outside the organization include sponsorship,

funding different associations, being ecofriendly, etc… (Mitchell R, 1992). The main

purpose of CSR is that the firm should be responsible for more than its commitment

towards its stakeholders. It must also be responsible for all the consequences of its

activities that are not due to economic results; however, it must consider the society and

environment resources (Robins, 2005). According to Garriga and Domenec, (2004), there

are four concepts of CSR: the instrumental, the political, the integrative, and the ethical.

The instrumental concept suggests that a business is a way to make profit and its social

activities are a tool to recognize the financial results. The political concept proposes that a

firm uses its power in the society in order to achieve political aims. The integrative concept

mainly focuses on the society’s necessities. Finally, the ethical concept is perceived when a

firm does all its ethical obligations towards the society.

A way to measure corporate social responsibility is by determining the corporate

social performance (CSP). A way to practice CSR and make it feasible is by CSP (Huang,

2010). Stakeholder theory is one way to evaluate CSP. The management and the

stakeholders’ interests are very essential for the continuity of any company (Tokoro, 2006).

However, management’s interests sometimes contradict stakeholders’ interests. Therefore,

the best thing to do is to maximize profit while meeting the interest of a wide range of

stakeholders (Jensen, 2002).

21
2.2 Earnings Management Practices

Arosa, Iturralde, and Maseda (2012) defined earnings management as “the process

of taking deliberate steps within the constraints of generally accepted accounting principles

to bring about a desired level of reported earnings.” While Li, Ho Park, and Shuji Bao

(2014) defined earnings management as the use of management perception in financial

statements and transactions structure to deceive stakeholders about the firm’s financial

performance or to attract external creditors. Chtourou et al. (2001), concluded that the

practices that best fit an organization are linked to less earnings management activities

which will lead to a better governance performance. The difference between earnings

management and fraud is that it uses the accounting principles and procedures which apply

to the Generally Accepted Accounting Principles (GAAP).

In their book, Ronen and Yaari (2007) differentiated between three types of earnings

management: the white, the black and the grey. White earnings management are the

beneficial ones in which they take advantage of the elasticity of choice in the accounting

treatment to improve the transparency of financial data. However, the black earnings

management are the pernicious ones in which they are used to misrepresent financial data,

decrease transparency of financial reports, and mislead stakeholders; this concept is close

to fraud. The grey earnings management are used when the firm uses the accounting

methods to either maximize the management value, or to increase the economic efficiency.

Several reasons lead to the practice of earnings management. For instance,

organizations might manage the earnings with the intention to affect the stock market

perceptions in order to raise their compensation. Hence, this decreases the possibility of

22
violating the lending agreements and avoiding the governing interventions (Healy et al.,

1999). Earnings management can cause severe and destructive influences on the future

performance of any organization according to previous studies that revealed evidence of the

harmful effects on the long term (Kao, Wu, & Yang, 2009). Nevertheless, wrong data about

the financial performance of the business will be delivered to stockholders and thus lead to

hostile choices (Bhattacharya, Daouk, & Welker, 2003).

2.3 Corporate Governance Components and Earnings Management

Practices

All components of corporate governance (transparency of financial statement,

ownership structure, board of directors, audit committee, and corporate social

responsibility) that were discussed earlier play a role in influencing earnings management

practices.

2.3.1 Transparency of Financial Statement and Earnings Management Practices

Transparency of financial statements help in detecting and reporting all forms of

earnings management practices. In a transparent atmosphere, any reader can easily detect

earnings management practices. Several examinations were done to study the influence of

transparency in reporting on the ability of users to identify earnings management (Hunton,

Libby, & Mazza, 2006). In general, many studies detected that the greater the transparency

in disclosures, the higher the recognition of earnings management. Usually, managers

prefer a lower transparency in disclosing formats like the addition of liabilities and

expenses in the closing notes and changes in the market value of stakeholder’s equity

23
(Hunton et al., 2006). Thus, managers consider that there is a benefit resulting from

depriving some shareholders’ ability to determine earnings management (Hunton et al.,

2006). According to a study done by Hunton et al. in 2006, members in a lower transparent

atmosphere reported that earnings management practices is not noticeable to users,

increases stock value, and do not have any influence on the reputation of management’s

honesty. On the contrary, this study added that participants in a higher transparent

atmosphere indicated that earnings management can easily be detected by users. Moreover,

this decreases stock value, and harms the management’s reputation. The results advocated

that an increase in the requirements of transparent reporting lowers the attempts of earnings

management practices in the part of high transparency or modifies the practices of earnings

management to more concealed techniques.

2.3.2 Ownership Structure and Earnings Management Practices

Because of its instability in the last few years, ownership structure has been

improved. According to Heubischl (2006), managers can control the firm more

independently in a more isolated share ownership. Since ownership structure has an

influence on management performance, and the latter can engage earnings management

practices, therefore, ownership structure indirectly has an effect on earnings management

practices.

Different predictions were deduced concerning managerial ownership and earnings

management. Some anticipated that when managerial ownership rises, the motivations to

modify in earnings decrease (Aygun, IC, & Sayim, 2014). However, other suggested that

when managers have high levels of ownership in the company, they might manipulate

earnings to increase their profits (Stulz, 1988). Previous studies showed that both

24
predictions were applicable. In addition, Warfield et al. in 1995 studied the managerial

influence on earnings management and they found that there is a negative correlation

between these two variables (Aygun et al., 2014). Similarly, a study that was done by

Gabrielsen Jeffrey and Thomas in 2002, found that there is a relation between managerial

ownership and earnings management in some different countries like the US and Denmark.

On the other hand, Yeo, Tan, Hoand Chen in 2002, conducted a similar study and found

that in Singapore there is a positive relation between those two variables. Also, the research

that was conducted by Aygun et al., in 2014, revealed that there is a significant relation

between ownership structure and earnings management.

In addition, earlier studies indicated that high amounts of institutional ownership

have a huge influence on corporate governance structure (Alves, 2011). It was expected

that institutional investors in comparison with individual investors have larger resources

and capabilities for an effective monitoring of managers (Aygun et al., 2014). As a result,

this will decrease the ability of managers to manipulate the company’s earnings (Chung,

Firth & Kim, 2002). Thus, the relation between institutional ownership and earnings

management is inversely related. Conversely, previous studies show diverse results

regarding the influence of institutional ownership on earnings management (Aygun et al.,

2014).

For example, in 2003, Koh examined the connection between the Australian

companies’ institutional ownership and strategies of aggressive earnings management. He

found that there is a positive correlation between these two variables which may propose

that institutional investors offer motivations for managers to change earnings. Likewise, Al-

Fayoumi, Abuzayed and Alexander in 2010, indicated that in Nigerian manufacturing

companies there is a positive significance between earnings management and institutional

25
ownership. However, one study suggested that there is a negative correlation between the

two variables that means high levels of institutional ownership. This signifies that the

monitoring of institutional investors is one of the elements that reduce managers’

manipulation of earnings (Aygun et al., 2014). Moreover, according to a study done in

Turkey there is a negative significance between institutional ownership and earnings

management (Aygun et al., 2014).

The combination of all these types of ownership plays a role in maintaining the

organization’s performance and reducing chances of earnings manipulation. According to

Hajiha and Farhani (2011), ownership structure is used in the corporate governance system,

or the firm’s management structure and decreases the cost of agency conflicts (Henryani &

Kusumastuti, 2013). As mentioned earlier that the conflict which happens between owners

and managers is the reason behind agency cost which caused several arguments related to

ownership structure. Investors, who have less ownership interests, or what is called by

dispersed ownership, lead to agency conflicts in companies because shareholders have little

incentives to take care of the strategic decisions of the management. Since they own a

small percentage of shares in the company, shareholders don’t feel that they own or have

control over the corporation (Fazlzadeh et al., 2011). Furthermore, dispersed investors

don’t have the qualified information and knowledge to make effective decisions (Lee,

2008). However, investors who own large percentage of shares in the company, or who are

also known as concentrated ownership reduce agency problems because they have strong

incentives and monitoring power over management decisions (Fazlzadeh et al., 2011); thus,

reducing the intentions of earnings manipulation.

26
2.3.3 Board of Directors and Earnings Management Practices

Prior studies supported the idea that the independence and effectiveness of board of

directors can more likely decrease earnings management practices (Klein, 2002).

Furthermore, studies that were conducted in the United Kingdom and United States from

1991 to 1993, through using a sample of 1,271 entities in the U.K. and 687 entities in the

U.S. found that directors independence play a key role in limiting earnings management

practices (Peasnell, Pope, & Young, 2005). On the other hand, some existing studies found

that there is no relation between the independence and usefulness of board of directors and

earnings management (Niu, 2006). According to Xie, Davvidson, and DaDalt (2003), there

is a negative association between the directors’ independence and earnings management

practices by examining a sample of 110 entities in the U.S. Besides, a study that was done

on Canadian corporations found that the board’s level of independence is not related to the

level of unusual accruals (Niu, 2006).

2.3.4 Audit Committee and Earnings Management Practices

In their study, Baxter and Cotter (2009), concentrated on the arrangement and

attributes of audit committee and its influence on enhancing earnings quality in Australian

organizations before applying mandatory prerequisites to the committees in the year 2003.

They found that audit committee decreases earnings management practices, but doesn’t

decrease the errors resulting from estimation of accruals. Additionally, the study found that

the financial experience of the audit committee members has a significance on affecting the

earnings management practices. Other features of audit committee didn’t have significance

on earnings management practices. Further studies also found different factors that impact

earnings management. For example, one study found that implementation and support of

27
the guidelines of corporate governance in the organization lead to enhancement in the

practices of earnings management (Teitel & Machuga, 2010). Another study found that

public entities are more traditional in their financial reporting than private firms, and their

management use of normal accruals is lower (Givoly, Hyn, & Katz, 2010). Thus, earnings

management practices in public firms are healthier than that in private ones and this is

because public firms wants to avoid agency costs and lawsuit risks (Hamdan, Mushtaha, &

Al-Sartawi, 2013).

According to a study done by Hamdan and Abu Ijeila (2010), audit committees in

Jordanian industrial firms have no association in limiting earnings management practices

(Hamdan et al., 2013). However, the study of Teitel and Machuga’s in 2010, revealed that

applying the rules of best corporate governance practices and external audit improves the

practices of earnings management.

2.3.5 Corporate Social Responsibility and Earnings Management Practices

In the absence of corporate social responsibility and the concentration on private

benefits, Prior, Surroca, and Tribo (2008) argue that managers have a higher tendency to

get involved in earnings management practices. Sometimes getting involved in earnings

management practices creates a probability of losing shareholders which is important for

the continuity of the firm (Prior et al., 2008). Therefore, managers get threatened from

different stakeholders influencing the organization’s real value which results in putting the

organization’s reputation under risk and managers might lose their job (Fomburn,

Gardberg, & Barnett, 2000). Consequently, managers have a motivation to engage

corporate social responsibility as a tactical way to recompense stakeholders and affect the

way they view the actual future of the organization, divert the attention from performing

28
any accounting based or real earnings management practices. Thus, contributing in CSR

activities is determined more by opportunistic actions than ethical vitals (Alsaadi, Jaafar, &

Ebrahim, 2013).

In addition, according to Scholtens and Kang (2013), when CSR practices in Asian

countries are engaged, there is a less tendency to perform earnings management practices.

Also, CSR behaviors have positive effects on protecting investors. Therefore, in Asian

countries earnings management practices are moderated by engaging in CSR activities

which are accustomed by the legal structure.

2.4 Hypotheses

H1: A higher transparency in the financial statements leads to lower earnings management

practices.

H2: An effective ownership structure leads to lower earnings management practices.

H3: A higher degree of independence and effectiveness of the board of directors leads to

lower earnings management practices.

H4: A more effective audit committee leads to lower chances of engaging in earnings

management practices.

H5: A higher level of corporate social responsibility leads to lower chances of engaging in

earnings management practices.

29
 Chapter III

METHODOLOGY

In this chapter, the methodology followed to conduct this study is presented. Each

phase of the standard approach of design analysis, measurement techniques, sample, data

collection, and statistical methods is discussed.

3.1 Design Analysis

Several methods can be used to measure earnings management practices. One of

these methods is the “Modified Jones Model” (Islam, Ali, & Ahmad, 2011). Previous

studies considered Modified Jones model an effective technique while others found it

ineffective. Those who considered it effective found that it is mostly beneficial in

developing economies. The main idea of this model is to split accruals into non-

discretionary and discretionary accruals. The change in receivables leads to a change in

sales, and this is where Standard Jones model is converted to Modified Jones model (Islam

et al., 2011).

The above technique isn’t used in this research instead a survey data collection was

conducted. Besides, the data was analyzed in accordance with a research goal which aims

to test the correlation between corporate governance and earnings management practices

with an intention to find the most effective way to decrease these practices.

All variables measured in the research were constructed in accordance with the

suggested hypotheses. The questionnaire includes the needed questions which implies on

30
the measured variables particularly corporate governance and earnings management

practices.

The questionnaire is divided into eight parts. The first part is the demographics

section which include age, gender, education, year of working experience, and certificates.

The second part consists of questions that are related to the transparency of financial data.

The third part tests the level of ownership structure. The fourth part examines the structure

of board of directors. The fifth part questions the level of corporate social responsibility.

The sixth part examines the effectiveness of audit committee. The final two parts include

questions about earnings management incentives and tools.

3.2 Measurement Techniques

The demographics section which is the first section starts from question 1 till

question 15, see Appendix A. The second section, containing all remaining parts of the

questionnaire begins with question 1 and ends at question 64, uses a Likert scale ranging

from strongly disagree to strongly agree. Questions 54 through 64 examine earnings

management incentives and tools. The corporate governance parts of the questionnaire are

taken from El-Kassar et al. (2014). The part related to earnings management is self-

developed based on several questionnaire found in the literature (Dima, Ionesscu, and

Tudoreanu, 2013; Khalil, 2010; El Mehdi & Seboui, 2011).

3.3 Sample

The targeted population are MBA, EMBA, LLM, and graduates of the Lebanese

American University working in different Lebanese corporations. The distributed surveys

31
were 110 in which 76 of them were collected, of which 70 of the 76 were found beneficial.

The participants answered the questions freely and with high confidentiality after being

thoroughly informed of the aim behind the research.

3.4 Data Collection

Correlation based methods were used to examine the level of corporate governance

practices and its connection with earnings management practices. Data collection was done

through questionnaires that were distributed among different employees. The data was

collected according to convenience due to time limitation. In order to examine the

hypotheses, scores for each corporate governance components were created: transparency

of financial statements, ownership structure, board of directors, audit committee, and

corporate social responsibility. Scores for earnings management incentives and tools were

made as well. These scores are denoted by the following:

TRSS: Transparency of Financial Data Score.

OWNS: Ownership Structure Data Score.

BDRS: Board of Directors’ Data Score.

ADTS: Audit Committee Data Score.

CSRS: Corporate Social Responsibility Data Score.

EMIN: Earnings Management Incentives Data Score.

EMIT: Earnings Management Tools Data Score.

The scores of the corporate governance components are used as the independent

variables. The scores of earnings management were used as the dependent variables.

32
After adjusting the responses of the negatively worded questions, the various scores were

created by averaging the responses. Hence, higher scores represent effective corporate

governance practices. On the other hand, higher earnings management scores represent

increase tendencies of earnings management practices. A copy of the survey distributed is

attached presented in Appendix A.

3.5 Statistical Methods

Using the scores constructed for each corporate governance component and the two

components of earning management. The statistical analysis to be conducted to study the

effect of corporate governance on earnings management practices. Correlations,

frequencies, Cronbach’s Alpha, and ANOVA are used to examine this effect.

33
 Chapter IV

FINDINGS ANALYSIS and DISCUSSION

Several statistical methods were used to test the hypotheses developed in chapter 2.

These included: descriptive statistics, correlative matrix, One-Way ANOVA and regression

analysis.

4.1 Descriptive Statistics

In this section, the demographic variables were analyzed using descriptive statistical

techniques.

4.1.1 Size of Company

First, the company size measured according to number of employees was considered. The

SPSS output resulted in the following distribution.

Table 1: Average Size of Companies with respect to Number of Employees

Size Valid Cumulative
Frequency Percent Percent Percent
Valid 1-9 10 14.3 14.3 14.3
10-19 6 8.6 8.6 22.9
20-50 13 18.6 18.6 41.4
> 50 41 58.6 58.6 100.0
Total 70 100.0 100.0

34
 Figure 1: Average Size of Companies with respect to Number of Employees

Note that company size was measured according to the number of employees

working in it. Out of the 70 companies that were questioned, ten were of a small size firms

in which they have between 1 and 9 employees; they have a frequency distribution of

14.3% of the sample. The middle sized companies that have from 10 to 19 employees were

6 firms representing 8.6% of the sample. In addition, some middle companies that have

between 20 and 50 working employees were 13 firms representing 18.6% of the sample.

Finally, large firms that have more than 50 employees were 40 in number and representing

58.6% of the sample.

35
4.1.2 Years of experience

Second, descriptive analysis of the companies’ years of experience revealed the

following:

Table 2: Average of Years of Experience for the Companies

Years of Valid Cumulative
Experience Frequency Percent Percent Percent
Valid <5 years 16 22.9 22.9 22.9
5-10 years 21 30.0 30.0 52.9
>10 years 33 47.1 47.1 100.0
Total 70 100.0 100.0

Figure 2: Average of Years of Experience for the Companies

Experience of the company was measured according to the number of years it has

been operating. Sixteen companies that have less than 5 years of experience represent

22.9% of the sample. Those that have an experience from 5 to 10 years were 21

36
respondents representing 30% of the sample. Finally, those that have a large experience,

which they have been operating for more than 10 years, were 33 firms representing 47.1%

of the sample.

4.1.3 Board of Directors Size

The descriptive statistics for the companies’ board size is shown in the following

SPSS output distribution.

Table 3: Average Board Size

BOD Valid Cumulative
Size Frequency Percent Percent Percent
Valid 1-4 13 18.6 18.8 18.8
5-10 32 45.7 46.4 65.2
>10 24 34.3 34.8 100.0
Total 69 98.6 100.0
Missing System 1 1.4
Total 70 100.0

37
 Figure 3: Average Board Size

Firms that have board members from 1 to 4 were 13 and represent an average of

18.6% of the sample. While firms that have a board that consists from 5 to 10 members

were 32 and represent 45.7% of the sample. Finally, large companies that have more than

10 members in the board were a total of 24 and represent 34.3% of the sample.

38
4.1.4 Board of Directors Meetings

The descriptive statistics of the companies’ board of directors meetings is

elaborated in the following SPSS output.

Table 4: Average Meetings of the Board of Directors

BOD Valid Cumulative
Meetings Frequency Percent Percent Percent
Valid 1-3 14 20.0 20.9 20.9
4-6 24 34.3 35.8 56.7
>6 29 41.4 43.3 100.0
Total 67 95.7 100.0
Missing System 3 4.3
Total 70 100.0

Figure 4: Average Meetings of the Board of Directors

The board of 14 companies, which meet between 1 to 3 times annually, represent

20% of the sample. However, the board that meets between 4 to 6 times annually were 24

39
firms and represent 34.3%. Lastly, 41.4% of the sample was represented by 29 corporations

whose board meets more than 6 times per year.

4.1.5 Sales

The companies’ sales was also considered in the descriptive statistics and is

presented in the below SPSS results.

Table 5: Average Sales

Sales Valid Cumulative
Frequency Percent Percent Percent
Valid <10,0000 7 10.0 11.7 11.7
100,000-499,000 17 24.3 28.3 40.0
500,000-1,000,000 8 11.4 13.3 53.3
>1,000,000 28 40.0 46.7 100.0
Total 60 85.7 100.0
Missing System 10 14.3
Total 70 100.0

Figure 5: Average Sales

40
 Corporations that have less than $100,000 sales were 7 and represent 10% of the

sample. While corporations that have sales between $100,000 - 499,000 represented 17

respondents equivalent to 24.3% of the sample. Firms that have sales between $500,000 -

1,000,000 were 8 companies represented 11.4% of the sample. Companies that have sales

more than $1,000,000 were 28 companies represented 40% of the sample.

4.1.6 Annual Sales over the Last 5 Years

The statistical description of the annual sales of the corporations over the last 5

years is shown in the SPSS output below.

Table 6: Average Annual Sales over the Last 5 Years

Difference in Sales Valid Cumulative
Frequency Percent Percent Percent
Valid decreased significantly 3 4.3 5.0 5.0
decreased slightly 4 5.7 6.7 11.7
no change 13 18.6 21.7 33.3
increased slightly 20 28.6 33.3 66.7
increased significantly 20 28.6 33.3 100.0
Total 60 85.7 100.0
Missing System 10 14.3
Total 70 100.0

41
 Figure 6: Average Annual Sales over the Last 5 Years

Corporations that experienced a significant decrease in sales in the last five years

were 3 and represented 4.3% of the sample. However, 4 corporations experienced a slight

decrease in sales over the past 5 years represented 5.7% of the sample. Companies

representing 18.6% of the sample were 13, which experienced no change in sales over the

last 5 years. Twenty firms experienced a slight increase in sales over the past 5 years

represented 28.6% of the sample. Similarly, 20 companies experienced a significant

increase in sales over the past 5 years represented 28.6% of the sample.

42
4.1.7 Debt

The descriptive statistics for the companies’ debt is shown in the following SPSS

output distribution.

Table 7: Average Debt

Debt Valid Cumulative
Frequency Percent Percent Percent
Valid 1-25% 24 34.3 39.3 39.3
26-50% 30 42.9 49.2 88.5
>50% 7 10.0 11.5 100.0
Total 61 87.1 100.0
Missing System 9 12.9
Total 70 100.0

Figure 7: Average Debt

43
 Corporations that have a debt between 1 and 25% of total assets, represents 34.3%

of the sample, which is equivalent to 24 firms. Companies having a debt between 26 and

50% represent 42.9% of the sample, and this is equivalent to 30 firms. Those that have a

debt greater than 50% were 7 respondents and represent 10% of the sample.

4.2 Reliability Analysis

The first step of the data analysis is to conduct liability analysis on each component

of corporate governance as well as the earnings management components. The Cronbach’s

Alpha (α) values were attained.

The reliability analysis for the all the components of corporate governance resulted

in the following output:

Table 8: Cronbach’s Alpha of CG and EM Components

Factors N Valid Item Cronbach’s Alpha

TRS 70 100% 9 0.932

OWN 70 100% 9 0.872

BRD 70 100% 19 0.954

ADT 70 100% 9 0.928

CSR 70 100% 7 0.903

EMI 70 100% 7 0.713

EMT 70 100% 4 0.661

` The above table shows the 70 collected surveys were 100% valid. Each factor

consisted of a different number of items ranging from 4 to 19 questions.

44
 All components of corporate governance and earnings management were checked

for reliability. A summary of the computer output is presented in table 8. Most of the results

show that all components had a Cronbach’s Alpha values well the minimum threshold of

0.7. Moreover, the two components of earnings management resulted of acceptable results

of 0.713 and 0.661. This indicates a high reliability of the survey instruments so we can

proceed with further statistical analysis.

Since most of the values are more than 0.7, we can deduce that all questions were

reliable and additional investigations can be done.

4.3 Correlation Analysis

The correlation analysis was designed to find the strength of the association

between corporate governance score and earnings management practices. Correlation

analysis reveals the following results given in Table 9.

Table 9: Correlation Matrix

TRSS OWNS BRDS CSRS ADTS CG EMIN EMTN

TRSS 1.000
OWNS .442 1.000
BRDS .616 .497 1.000
CSRS .548 .332 .697 1.000
ADTS .671 .526 .609 .595 1.000
CG .717 .671 .921 .803 .818 1.000
EMIN -.372 -.122 -.376 -.410 -.320 -.394 1.000
EMTN -.263 -.153 -.218 -.309 -.184 -.263 .103 1.000

70 sample size
± .235 critical value .05 (two tail)
± .306 critical value .01 (two-tail)

45
 The correlation matrix reveals that there is a strong negative correlation between

earnings management incentives score and each corporate governance score. The

correlation coefficients vary from -0.122 to -0.410. Moreover, the results reveal that all

correlation coefficients are significant, except for the one corresponding to the ownership

structure. These support hypotheses H1, H3, H4 and H5. Also, the effects on earnings

management incentives listed in increasing order are: audit committee, transparency of

financial statements, board of directors, and finally the most effective corporate social

responsibility (-0.410). From this, a good practice to reduce earning management

incentives is to enhance corporate governance practices in terms of

The above table reveals that corporate social responsibility have the highest

influence on reducing earnings management incentives with a -0.410 score. The board of

directors with a score of -0.376 also has a high influence on reducing earning management

incentives. The transparency of financial data occupies the third place in reducing earnings

management practices with a -0.372 score. The least influencing factor of corporate

governance on earnings management practices is ownership structure with a score of -

0.122.

Obviously, companies which are high on CSR practices value the well-being of the

society. This indicates, that companies are being more ethical, professional, and consistent

with the laws and legislations. Thus, this leads to the thought that people working for these

companies will not be practicing unfavorable activities of earnings management because

they are involved in the welfare of the society. Moreover, engaging CSR is not only being

ethical, but also improving the firm’s reputation. This contributes to the idea that the

corporation is a proactive one which in turn will diminish any kind of negative image.

Furthermore, being socially responsible encourages employees to be ethical and act as a

46
role model for others which will deter them from doing any unfavorable practices of

earnings management. These results are consistent with a prior study done by El-Kassar et

al., (2015) indicating that high practices of CSR improves the performance of corporate

governance as well as it raises the level of ethnicity and ethics among employees.

Similarly, Prior et al., (2008) indicated that with the absence of CSR, there is a high

tendency for engaging earnings management practices.

Moreover, it can be concluded from the above correlation analysis results that a

higher degree of board of directors’ independence and effectiveness would also lead to

lowering the earnings management practices, but to a lesser extent than that of CSR. This is

because the independent board members, who are outsiders, may have easier access to all

information and data where they can take actions and decisions without any pressure from

shareholders. The same result was conducted by the study of Peasnell et al., (2005) stating

that independence plays a key role in limiting earnings management practices. Equally as

important a higher transparency in terms of financial statements resulted in lowering

earnings management practices. Transparency means clarity and honesty. Clarifying and

reporting all financial activities occurring within the firm and with other parties, makes it

hard to carry out any unfavorable practice of earnings management. This result confirms

the study of Hunton et al. in 2016 signifying that high levels of transparency will easily

expose earnings management practices. Finally, the effectiveness of the audit committee

has an influence on reducing earnings management incentives. Slightly it is at a lower rate

than the board independence and effectiveness and the degree of transparency in the

financial statements. It is well known that the audit committee oversees the work of internal

auditors and helps external auditors to a huge extent. This leads to the belief that audit

committee watches over financial and non-financial activities.

47
It also controls all the actions of internal auditors which makes it hard to engage in any

unfavorable act of earnings management. This is why audit committee heavily influence

the incentives of earnings management rather than the tools. Also, the study done by Baxter

and Cotter (2009) confirm that effectiveness of audit committee decreases the practices of

earnings management. However, the effectiveness of ownership structure doesn’t influence

earnings management practices because owners aren’t involved in the operations of the

company. This contradicts the results of a study done by Aygun et al., (2014) which

revealed that there is a great significance between the ownership structure and earnings

management practices detection.

Based on this, companies that are seeking to limit or prevent any earnings

management practices should aim to have a higher degree of independence and

effectiveness of the board of directors, have a higher transparency in the presentation of

financial reporting, and intend to have a more effective audit committee. All these can be

achieved within the firm. Besides, the importance of corporate governance in terms of CSR

should be closely applied in order to prevent earnings management practices. Nevertheless,

this will require promotion of ethical behavior to hire managers and employees who value

CSR, and heavily engage in CSR activities both internally and externally. Internally, it

could be done by directing CSR practices to employees and other stakeholders. Externally,

the company should direct its CSR efforts to society, government, and customers. Unless

this practice of CSR was conducted at all levels, lowering earnings management practices

may not be achieved.

48
4.4 ANOVA

In the following, Analysis of Variance (ANOVA) tests are conducted to determine

whether significant differences in corporate governance and earning management practices

across the various categories of the demographic variables Size of the Company, Board

Size, Years of Experience, Sales, Difference in Sales, and Debt.

4.4.1 Size and Earnings Management Incentives

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of company size.

Table 10: Comparison of Means between the Size of the Company and EM Incentives
Std. Std.

N Mean Deviation Error Minimum Maximum

1-9 10 3.524 .7409 .2343 1.7 4.1
10-19 6 4.027 .2755 .1125 3.8 4.6
20-50 13 3.790 .5714 .1585 3.0 4.7
> 50 41 3.581 .5388 .0841 2.4 4.7
Total 70 3.650 .5687 .0680 1.7 4.7

Table 11: One-way ANOVA for the Size of the Company and EM Incentives
Sum of Mean
Squares df Square F Sig.
Between Groups 1.466 3 .489 1.546 .211
Within Groups 20.851 66 .316
Total 22.317 69

Applying a One Way ANOVA, at a level of significance of 0.05, the effect of the

company’s size on earnings management incentives is tested. It was found that the 10

companies that have 1 to 9 employees have an average earnings management incentive of

49
3.52. The average earnings management incentive increased to 4.02 as the company size

increased to 10-19 employees. However, average earnings management incentive decreased

to 3.79 as the size of the company increased to reach 50 employees after which earnings

management incentive continued decreasing to reach 3.58 with a number greater than 50

employees. In general, the size of the company does not have an effective significance on

earnings management incentive. In this case, small and large companies do not have high

earnings management incentive relative to middle sized companies.

4.4.2 Years of Experience and Earnings Management Incentives

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of the companies’ years of experience.

Table 12: Comparison of Means between Years of Experience and EM Incentives

Std. Std. Minimu Maximu
N Mean Deviation Error m m
<5 years 16 3.701 .5231 .1308 2.6 4.7
5-10 years 21 3.442 .6587 .1437 1.7 4.6
>10 years 33 3.757 .5063 .0881 2.4 4.7
Total 70 3.650 .5687 .0680 1.7 4.7

Table 13: One-way ANOVA for Years of Experience and EM Incentives

Sum of
Squares df Mean Square F Sig.
Between Groups 1.332 2 .666 2.126 .127
Within Groups 20.985 67 .313
Total 22.317 69

Entities that have been operating for less than 5 years, have an average earnings

management incentive of 3.70. Those that have been operating for 5 to 10 years have an

average earnings management incentive of 3.44. The average earnings management

50
incentive increases to 2.75 for companies that have been operating for more than 10 years.

There is no overall significance (0.127) between years of experience and earnings

management incentives.

4.4.3 Board of Directors Size and Earnings Management Incentives

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of companies’ board size.

Table 14: Comparison of Means between the BOD Size and EM Incentives
Std. Std.

N Mean Deviation Error Minimum Maximum

1-4 13 3.350 .6769 .1877 1.7 4.0
5-10 32 3.785 .4656 .0823 2.4 4.7
>10 24 3.618 .5976 .1220 2.6 4.7
Total 69 3.645 .5715 .0688 1.7 4.7

Table 15: One-way ANOVA for the BOD Size and EM Incentives
Sum of
Squares df Mean Square F Sig.
Between Groups 1.780 2 .890 2.875 .064
Within Groups 20.433 66 .310
Total 22.213 68

Companies that have 1-4 board members have an average earnings management

incentive of 3.35. This average increased to reach 3.78 as a number of board member

increased to reach to reach 10. As the board members increase to become greater than 10

members, the average earnings management incentives decreased to become 3.61. The

overall number of board members has nothing to do with earnings management incentives

with a significance less than 0.05.

51
4.4.4 Sales and Earnings Management Incentives

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of companies’ sales.

Table 16: Comparison of Means between Sales and EM Incentives

Std. Std. Minim Maximu
N Mean Deviation Error um m
<100000 7 3.389 .8601 .3251 1.7 4.2
100000-499000 17 3.825 .4323 .1048 3.1 4.6
500000-1000000 8 3.556 .4104 .1451 3.0 4.0
>1000000 28 3.584 .5321 .1006 2.4 4.7
Total 60 3.626 .5431 .0701 1.7 4.7

Table 17: One-way ANOVA for Sales and EM Incentives

Sum of
Squares df Mean Square F Sig.
Between Groups 1.152 3 .384 1.323 .276
Within Groups 16.252 56 .290
Total 17.404 59

Entities that have sales less than $ 1,000,000 have an average earnings management

incentive of 3.38. However, entities that have sales between $1,000,000 and 499,000 have

an average earnings management incentive of 3.82. Similarly, companies that have sales

between $500,000 and 1,000,000 have an average earnings management incentive of 3.55.

Average earnings management incentive increased to 3.58 for the companies that have

annual sales greater than $1,000,000. It is conducted that in general there is no significance

between the annual sales of the company and its earnings management incentive with a

significance less than 0.05.

52
4.4.5 Difference in Sales and Earnings Management Incentives

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of companies’ difference in sales over the past 5 years.

Table 18: Comparison of Means between Difference in Sales and EM Incentives

Std. Std.
N Mean Deviation Error Minimum Maximum
Decreased 7 3.342 .9860 .3727 1.7 4.6
no change 13 3.697 .5776 .1602 2.4 4.5
increased slightly 20 3.660 .5136 .1148 2.6 4.7
increased significantly 20 3.674 .3196 .0715 3.0 4.4
Total 60 3.635 .5443 .0703 1.7 4.7

Table 19: One-way ANOVA for the Difference in Sales and EM Incentives
Sum of Mean
Squares df Square F Sig.
Between Groups .692 3 .231 .769 .516
Within Groups 16.790 56 .300
Total 17.482 59

Firms that have experienced a significant decrease and a slight decrease in sales

have an average earnings management incentive of 3.04. This average increased slightly to

3.69 for those companies that did not experience any change in sales. Companies that

experienced a slight increase in its sales have an average earnings management incentive of

3.66. Finally, companies that experienced a significant increase in sales, have an average

earnings management incentive of 3.67. This means that there is no general relation

between change in sales and earnings management incentive with a significance of less

than 0.05 (0.43).

53
4.4.6 Debt and Earnings Management Incentive

The following is the output of the ANOVA test of Earnings Management Incentives

across the various categories of companies’ debt as a percent of total assests.

Table 20: Comparison of Means between Debt and EM Incentives

Std. Std.
N Mean Deviation Error Minimum Maximum
1-25% 24 3.727 .5573 .1138 2.6 4.7
26-50% 30 3.648 .4634 .0846 2.6 4.6
>50% 7 3.544 .8959 .3386 1.7 4.5
Total 63 3.651 .5677 .0715 1.7 4.7

Table 21: One-way ANOVA for Debt and EM Incentives

Sum of Mean
Squares df Square F Sig.
Between Groups .716 3 .239 .731 .537
Within Groups 19.266 59 .327
Total 19.982 62

Companies that have debt, as a percentage of total assets, between 1 and 25% have

an average of earnings management incentive of 3.72. As the percentage of debt decreased

slightly between 26 to 50%, average earnings management incentive decreased to reach

3.64. Finally, as Debt rises above 50%, average earnings management incentive slight

decreases till 3.54. It can be concluded that there is no significant relationship between debt

and earnings management incentive at the 5% confidence level.

54
4.4.7 Size and Earnings Management Tools

The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of company size with respect to number of employees.

Table 22: Comparison of Means between Size of the Company and EM Tools
Std. Std.

N Mean Deviation Error Minimum Maximum

1-9 10 2.775 .7308 .2311 1.8 4.5
10-19 6 3.000 1.0368 .4233 1.8 4.5
20-50 13 2.615 .8577 .2379 1.3 4.3
> 50 41 2.896 .9168 .1432 1.0 5.0
Total 70 2.836 .8815 .1054 1.0 5.0

Table 23: One-way ANOVA for Size of the Company and EM Tools
Sum of
Squares Df Mean Square F Sig.
Between Groups .981 3 .327 .410 .746
Within Groups 52.630 66 .797
Total 53.611 69

Significance is at 0.05. By using one way ANOVA to test the effect of the

company’s size on earnings management tools, it was found that the 10 companies that

have 1 to 9 employees have an average earnings management tools of 2.77. The average

earnings management tools increased to 3 as the company size increased by 10-19

employees. However, average earnings management tools decreased to 2.61 as the size of

the company increased to reach 50 employees after which earnings management tools

increased to reach 2.89 with a number greater than 50 employees. In general, the size of the

company does not have a significant effect on earnings management tools (0.746).

55
4.4.8 Years of Experience and Earnings Management Tools
The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of companies’ years of experience.

Table 24: Comparison of Means between Years of Experience and EM Tools

Std. Std. Minimu Maximu

N Mean Deviation Error m m

<5 years 16 2.906 .5764 .1441 1.8 4.3
5-10 years 21 3.048 1.1501 .2510 1.0 5.0
>10 years 33 2.667 .7947 .1383 1.3 4.8
Total 70 2.836 .8815 .1054 1.0 5.0
Table 25: One-way ANOVA for Years of Experience and EM Tools

Sum of
Squares df Mean Square F Sig.
Between Groups 1.966 2 .983 1.275 .286
Within Groups 51.645 67 .771
Total 53.611 69

Entities that have been operating for less than 5 years, have an average earnings

management tools of 2.9. Those that have been operating for 5 to 10 years have an average

earnings management tools of 3.04. The average earnings management tools decreased to

2.66 for companies that have been operating for more than 10 years. Overall, there is no

significance (0.28) between years of experience and earnings management tools.

56
4.4.9 Board of Directors Size and Earnings Management Tools

The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of companies’ board size.

Table 26: Comparison of Means between the BOD Size and EM Tools
Std. Std.

N Mean Deviation Error Minimum Maximum

1-4 13 3.000 .6922 .1920 2.3 4.5
5-10 32 2.609 .8979 .1587 1.0 5.0
>10 24 3.094 .8871 .1811 1.3 4.8
Total 69 2.851 .8780 .1057 1.0 5.0

Table 27: One-way ANOVA for the BOD Size and EM Tools
Sum of
Squares df Mean Square F Sig.
Between Groups 3.571 2 1.786 2.413 .097
Within Groups 48.844 66 .740
Total 52.415 68

Companies that have 1 -4 board members have an average earnings management

tools of 3. This average decreased to reach 2.6 as the number of board members increased

to reach 10. As the board members increase to become greater than 10 members, the

average tools increase to become 3.09.

57
4.4.10 Sales and Earnings Management Tools

The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of companies’ sales.

Table 28: Comparison of Means between Sales and EM Tools

Std. Std. Minimu Maximu

N Mean Deviation Error m m

<100,000 7 3.429 .9433 .3565 2.3 4.8
100,000-499,000 17 2.382 .9105 .2208 1.0 4.5
500,000-1,000,000 8 2.594 .4807 .1699 2.0 3.5
>1000000 28 3.009 .7978 .1508 1.8 5.0
Total 60 2.825 .8701 .1123 1.0 5.0

Table 29: One-way ANOVA for Sales and EM Tools

Sum of
Squares df Mean Square F Sig.
Between Groups 7.256 3 2.419 3.621 .018
Within Groups 37.406 56 .668
Total 44.663 59

Entities that have sales less than $1,000,000 have an average earnings management

tools of 3.42. However, entities that have sales between $1,000,000 and $499,000 have an

average earnings management tools of 2.38. Similarly, companies that have sales between

$500,000 and $1,000,000 have an average earnings management tools of 2.59. Average

earnings management incentive increased to 3.00 for the companies that have annual sales

greater than $1,000,000. There is a significance between the annual sales of the company

and its earnings management tools with a significance less than 0.05. It can be concluded

that earnings management tools increase as long as the company’s revenue is less than

$100,000 and more than $1,000,000. This is because firms that have less sales considered

58
small ones where they try to avoid taxes through practicing earnings management. Besides,

firms that attain high revenues are considered large size companies where the owners are

different from the managers. Thus, agency theory will occur, and managers will look for

methods and tools to manipulate earnings for their own benefit.

4.4.11 Difference in Sales and Earnings Management Tools

The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of companies’ difference in sales over the last 5 years.

Table 30: Comparison of Means between the Difference in Sales and EM Tools
Std. Std.

N Mean Deviation Error Minimum Maximum

decreased significantly 3 3.250 1.2990 .7500 2.5 4.8
decreased slightly 4 3.625 1.1815 .5907 2.0 4.5
no change 13 2.865 1.1530 .3198 1.3 5.0
increased slightly 20 2.563 .8424 .1884 1.0 4.3
increased significantly 20 2.763 .5224 .1168 1.8 4.3
Total 60 2.800 .8899 .1149 1.0 5.0

Table 31: One-way ANOVA for the Difference of Sales and EM Tools
Sum of
Squares df Mean Square F Sig.
Between Groups 4.542 4 1.135 1.480 .221
Within Groups 42.183 55 .767
Total 46.725 59

Firms that have experienced a significant decrease in sales have average earnings

management tools of 3.25. However, those that experienced a slight decrease in sales have

average earnings management tools of 3.62. This average decreased slightly to 2.86 for

those companies that did not experience any change in sales .Companies that experienced a

59
slight increase in its sales have an average earnings management tools of 2.56. Finally,

companies that experienced a significant increase in sales, have an average earnings

management tools e of 2.76. This means that there is no overall relation between change in

sales and earnings management tools with a significance of less than 0.05 (0.22).

4.4.12 Debt and Earnings Management Tools

The following is the output of the ANOVA test of Earnings Management Tools

across the various categories of companies’ debt as a percentage of total assets.

Table 32: Comparison of Means between Debt and EM Tools

Std. Std.

N Mean Deviation Error Minimum Maximum

1-25% 24 2.823 .9281 .1894 1.0 4.8
26-50% 30 2.742 .7086 .1294 1.3 4.8
>50% 7 2.821 1.1965 .4522 1.3 4.5
Total 63 2.841 .8972 .1130 1.0 5.0

Table 33: One-way ANOVA for Debt and EM Tools

Sum of
Squares df Mean Square F Sig.
Between Groups 6.672 3 2.224 3.034 .036
Within Groups 43.241 59 .733
Total 49.913 62

Companies that have debt, as a percentage of total assets, between 1 and 25% have

an average of earnings management tools of 2.82. As the percentage of debt decreased

slightly between 26 to 50%, average earnings management tools decrease to reach 2.74.

Finally, as debt increases above 50%, average earnings management tools slight decreases

60
till 2.82. It can be concluded that there is significant relationship between debt and earnings

management tools with a significance of less than 0.05(0.036).

As a summary, the results of the ANOVA test reveal significant differences exist in

earnings management for really large companies that have more than 50 employees and

very small firms that have less than 10 employees. In addition, firms having small board

size from 1 to 4 are more likely to have less earnings management practices. On the other

hand, medium size companies with a larger board size, from 5-10 members, tend to witness

more earnings management practices.

61
 Chapter V

CONCLUSION

This chapter of the study includes: summary, conclusion and recommendations, and

future research.

5.1 Summary

This study was done to find how each component of corporate governance

influences earnings management practices. Every chapter in the study was designed to

analyze the topic researched. For this study to be completed, data was collected from

different employees in order to examine the effect of transparency of financial statements,

ownership structure, board of directors, audit committee, and corporate social responsibility

on earnings management practices.

Chapter I, represented an overview of corporate governance in general, and its

importance in the organization’s mechanism. It also included a general idea about earnings

management practices. Then, a purpose of the study was presented by stating the

augmented concern about corporate governance and earnings management. In addition,

Chapter II included the literature review which stated prior studies’ findings and deduced

the hypotheses that were tested. Different results of several examiners were presented

which discussed the components of corporate governance and their influence on earnings

management practices. The methodology which was chapter III in this study, stated the

dependent and independent variables and also explained the measurement techniques,

sample, data collection, and statistical methods. Chapter IV, stated the results and analysis,

62
used several tests to examine the hypotheses. Correlation matrix analysis was first used to

show a significance between corporate governance components and earnings management

practices mainly CSR, board of directors, transparency of financial reports, and audit

committee. However, ownership structure showed no significance on earnings management

practices. Then, a descriptive analysis was done on some factors that might influence

earnings management practices like the size of the firm, size of the board of directors,

sales, etc… Finally, a comparison of means was done using One-Way ANOVA which

explored the relation between the above factors and earnings management tools and

incentives.

5.2 Conclusion and Recommendations

Nowadays, the main issue that organizations are aiming for is sustaining a good

corporate governance. This is mainly done by focusing on the job of each corporate

governance component. The main purpose of this study is to indicate the effectiveness of

transparency of financial statements, ownership structure, board of directors, audit

committee, and corporate social responsibility on earnings management practices. Finding

the influence of these components help firms to manage corporate governance properly and

control earnings management practices. According to the results, firms must invest more in

their social work which will give relief for stakeholders and distract managers from

engaging earnings management practices. Also, corporations must highly improve the

transparency of its financial statements as well as the independence and effectiveness of

board of directors which will help in taking decisions freely for the favor of shareholders

and limiting any unfavorable practices of earnings management.

63
 As mentioned earlier, the CSR should be closely implemented by firms in order to

limit the practices of earnings management and improve the performance of corporate

governance. This will be done firstly by promoting the ethical behavior within the firm’s

stakeholders. Thus, it is recommended to set up a code of ethics and encourage

stakeholders to abide by it, implement plans that support the ethical and moral culture of

the firm, reward employees who act ethically and fire those who do not, then, implement

CSR externally by helping the society to be make a better place for living.

5.3 Future Research

Additional studies could be done to examine the relationship between corporate

governance component and earnings management practices. Each component of the

corporate governance whether the transparency of financial statements, the ownership

structure, the board of directors, the audit committee, or the corporate social responsibility

can be investigated more deeply by preparing questionnaires targeting only one component.

Moreover, testing every component thoroughly will help in a sincere investigation of the

relation between each component and earnings management practices alone. This is

important to improve the effectiveness of corporate governance, and as a result, the

corporation’s performance.

64
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 Appendix A

Questionnaire

This is a research project and for this project you will be asked to complete a short
questionnaire. This questionnaire aims to study the effect of corporate governance
components on earnings management practices.
The information you provide will be used to identify any educational needs which can be
implemented.
Your answers will not be released to anyone and your identity will remain anonymous.
Your name will not be written on the questionnaire or be kept in any other records. All
responses you provide for this study will remain confidential. When the results of the
study are reported, you will not be identified by name or any other information that
could be used to infer your identity. Only researchers will have access to view any data
collected during this research. Your participation is voluntary and you may withdraw from
this research any time you wish or skip any question you don’t feel like answering. Your
refusal to participate will not result in any penalty or loss of benefits to which you are
otherwise entitled to.
The research intends to abide by all commonly acknowledged ethical codes. You agree to
participate in this research project by filling the following questionnaire. Thank you for
your time.
If you have any questions, you may contact:

Name (PI) Phone number Email address

Dr. Walid ElGammal [email protected]

If you have any questions about your rights as a participant in this study, or you want to
talk to someone outside the research, please contact the: IRB Office,

Lebanese American University

rd
3 Floor, Dorm A, Byblos Campus
Tel: 00 961 1 786456 ext. (2546)

78
Part I: Please tick or/ circle the appropriate answer

1) Your organization size: a) 1 - 9 employees b) c) 10 - 19 employees

20 - 50 employees d) > 50 employees

2) Your organization’s board of directors size:

a) 1 - 4 members; b) 5 - 10 members; c) > 10 members

3) How many times does the board meet per year?

a) 1 - 3 times b) 4 - 6 times c) > 6 times

4) CEO compensation:

a) < $ 50,000 b) $ 50,000 - 99,000 $ c) $ 100,000 - 149,000

d) $ 150,000 - 250,000 e) > $ 250,000

5) How often do family members who are not members of the legal board attend the
meeting?
a) Always b) Sometimes c) Never
6) Do family members engage and participate in board decisions?

a) Yes b) No

7) Approximately what are the sales revenues per year?

a) < $ 100,000 b) $ 100,000 - 499,000 c) 500,000 - 1,000,000 $

d) > $ 1,000,000

8) Over the past five years the average annual sales revenue has:

a) Decreased significantly b) Decreased slightly c) No change

d)Increased slightly e)Increased significantly

79
 9) Combined long term and short term debt is approximately what % of equity?

a) 0 - 25% b) 26 - 50% c) > 50%

10) Qualifications: a) No degree b) Graduate

11) Specialization: a) Accounting and auditing b) Banking science

c) Business Administration d)Another set

12) Years of experience: a) ˂ 5 years b) 5-10 years c) ˃ 10 years

13) Professional certificate: a) CA b) CPA c) CIA d) Another set e) Nothing

14) Age: a) ˂ 30 years b) 30-40 years c) ˃ 40 years

15) Gender: a) Male b) Female

Part II: For each of the questions, please tick the most appropriate answer where SD
represents Strongly Disagree, D represents Disagree, N represents Neutral, A represents
Agree, and SA represents Strongly Agree. There is an ample level of transparency of
financial data in terms of
SD D N A SA

1) Financial results

2) Objectives of the company

3) Accounting evaluations

4) Related party transactions: elements and nature

5) Related party transactions: practices and disclosure

(under control)
6) Board’s duties and financial communications

7) Extraordinary transactions regulations

8) Alternative accounting decisions: impact and analysis

9) The process for decision making and approval of

transactions with related parties

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Part III: For each of the questions, please tick the most appropriate answer. There is an
ample level of Ownership structure and control privileges
SD D N A SA

10) Structure of ownership

11) Control organization

12) Control and equity stake

13) Control privileges

14) Existence of meeting agenda

15) Procedures for holding annual meetings

16) Shareholders diversity

17) Actions for Anti-Takeovers

18) Regulations that cover and guide the corporate

control

Part IV: For each of the questions, please tick the most appropriate answer. There is an
ample level of Structure of Board of Directors and Management in terms of
SD D N A SA

19) Structure and goals of risk management

20) Board of directors structure: non-executives versus

executive
21) Information about board members such as
qualifications and biographical information
22) Responsibilities and positions of outside board
members
23) Position held by the executives and the number of
outside board members
24) Checks and balances instruments

25) Presence of a succession plan

26) Conflict of interest prevention through committees and

governance procedures
27) Governance committee composition and main task

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 28) Board of directors: function and role

29) Length of contracts for directors

30) Composition of the remuneration of directors and its

determinants
31) Number of independent board members

32) Professional activities for training and development

33) Reimbursement plan for senior managers in special

cases such as merger and acquisition
34) Presence of procedures covering conflicts of interest
among board members
35) Existence of advisors during reporting period

36) Process for evaluating performance

37) Management and board members’ material interests

Part V: For each of the questions, please tick the most appropriate answer. There is an
ample level of Corporate Social Responsibility in terms of
SD D N A SA

38) Performance based on social responsibility and

environmental awareness
39) Firm’s sustainability as a function of social
responsibility guidelines
40) Regulations to protect the rights of all business
stakeholders
41) Code of Ethics for board members

42) Ethical code of conduct for all the employees

43) Awareness of all the employees about corporate

governance and their role in implementing it
44) Strategy to protect employees against whistle blowers

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Part VI: For each of the questions, please tick the most appropriate answer regarding the
existence and effectiveness of the following elements (Auditing committee)
SD D N A SA

45) Procedures governing collaboration with external

auditors
46) Procedures and responsibilities for appointing internal
auditors
47) Reliability of external auditors and board’s confidence

48) Procedures governing collaboration with internal

auditors
49) Decision making procedure for appointing external
auditors
50) Internal control systems

51) Period of auditor contracts

52) Audit partner rotation process

53) The remuneration of auditors and involvement in other

services non-audit work

Part VII: For each of the questions, please indicate to which extent management desires
(incentives)
SD D N A SA

54) To improve bonuses

55) To avoid debt contracts

56) To avoid political costs resulting from legislations and

government interventions
57) To meet the expectations of financial analysts

58) To increase the market price of the share at its first and
second issuance
59) To own shares in order to take control over the
organization
60) To influence the extent and volume of transactions with
customers and suppliers in the future

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Part VIII: For each of the questions, please indicate to which level profits are managed
through (tools)
SD D N A SA

61) Under/overestimation of accrual accounts of

discretionary earnings management
62) Category conversion through the exceptional items

63) Category conversion through the discontinued

operations
64) Under/Overrepresentation of real activities

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