Corporate governance and the quality of accounting earnings: a Canadian perspective

Abstract

Purpose The paper seeks to examine the association between corporate governance mechanisms and the quality of accounting earnings. Design/methodology/approach Quality of earnings is measured in two ways: the accounting‐based measure of earnings management and the market‐based measure of earnings informativeness. Using firm‐level corporate governance data for a sample of Canadian firms in the years 2001‐2004, regression analysis explores the relation between corporate governance (including board composition, management shareholding, shareholders' rights and the extent of disclosure of governance practices), and the quality of earnings. Findings Empirical tests demonstrate that overall governance quality is negatively related to the level of abnormal accruals and positively influences the return‐earnings association. In addition, the magnitude of abnormal accruals is negatively associated with the level of independence of board composition, the extent of alignment of management compensation with interests of shareholders and the strength of shareholder rights. The results from the returns and earnings analysis are consistent with these findings. Research limitations/implications The tests in this study are association tests. Future research may use qualitative research approaches to examine the link between quality of financial reporting and governance effectiveness. Originality/value This study provides evidence that supports Canadian regulators' initiatives that stronger corporate governance mechanisms provide greater monitoring of the financial accounting process and may be important factors in improving the integrity of financial reporting.