Academic journal article Academy of Accounting and Financial Studies Journal

The Effect of Corporate Governance Attributes on Accounting Conservatism in Egypt

Academic journal article Academy of Accounting and Financial Studies Journal

The Effect of Corporate Governance Attributes on Accounting Conservatism in Egypt

Article excerpt

INTRODUCTION

Corporate governance facilitates contracting as it encourages adopting conservatism in financial reports (Fama & Jensen, 1983). Conservative accounting is an element of financial reporting quality because it alleviates agency conflicts as managers give a timely account of bad news instead of good news, thus reducing the managers' opportunity to manipulate financial reporting. It is a helpful implement for the board of directors to perform its role in controlling management (Ahmed & Duellman, 2007). Therefore, effective corporate governance and a high level of accounting conservatism will increase the company's financial reporting quality. The literature notes that alleviating agency problems, enhancing contractual agreements, reducing litigation costs, good decision making, and reducing information asymmetry are the results of conservative reporting (Ahmed & Duellman, 2007; Affes & Sardouk, 2016). Consequently, under situations of uncertainty and economic difficulties, accounting conservatism is required for the financial reporting process. Conservatism restricts opportunistic management to grantee the shareholders' interests and increases the firm's value. The relationship between the board characteristics and the quality of financial reports has been investigated in the literature. Xie et al. (2003) reported that the ratio of external directors has a negative effect on the proxy of earnings management. Companies that have a higher rate of external directors are more likely to recognize losses in a timely manner than companies with a low rate of external directors (Mohammed et al., 2017; Ahmed & Duellman, 2007). The board monitors managers and conservative accounting as a good measure of the agency's conflict. Therefore, the relation between the board characteristics and accounting conservatism has to be investigated.

Owners significantly influence specific forms of management decisions about conservative reporting. Prior literature argues that the ownership structure is a key element in corporate governance attributes that reduce incentives for earnings management and the mechanism for equilibrium shareholder interests to increase the significance of financial reporting (Liu, 2019; Lin, 2016; Song, 2015). The ownership structure supports maintaining conservative accounting and reducing managers' practices when choosing accounting policies to increase their benefits.

This study intends to answer the question of: What is the effect of corporate governance on the level of conservatism in financial reports in Egypt? As with the corporate governance mechanisms investigated in prior research, the corporate governance attributes used in this study include board structure, ownership structure, and audit type. Board characteristic and ownership structures are utilized as a proxy of internal corporate governance mechanisms and audit quality as a proxy of an external mechanism. The board characteristic variables are bored size, board independence, and CEO/Chair separation. The ownership structure variables are managerial ownership, institutional investors, and large block ownership.

The approach of Givoly & Hayn's, (2000) is used to measure the level of accounting conservatism. Balanced data of the 40 most active non-financial firms were utilized during the period 2009-2014 to test the proposed hypothesis. This paper contributes to the literature by providing decision-makers and regulators in Egypt with suggestions on improving corporate governance practices, as conservatism is a substitute for good governance.

The rest of the paper is organized as follows. The next section discusses the theoretical background and hypothesis development. Then clarify the research method, followed by providing the empirical results. The conclusions, recommendations, and limitations are in the last section.

THEORETICAL BACKGROUND AND HYPOTHESIS DEVELOPMENT

Corporate Governance and Accounting Conservatism

Corporate governance is a tool for maintaining conservative accounting and reducing agency problems. …

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