Earnings Management and Corporate Governance Mechanism: Evidence from Non-Financial Sector of Pakistan

Abstract

Background: Corporate governance (CG) is a vital aspect of the business environment, as it sets the framework for the proper functioning of management and board of directors. Earnings management (EM) is an important issue in financial reporting, as it affects the decision-making of investors and stakeholders, and the credibility of financial statements. Coalition between EM and CG mechanisms has been area of interest for researchers globally.

Objectives: The research examined the association between EM and CG mechanisms in non-financial sector of Pakistan.

Method: We used 400 samples acquired from 40 non-financial firms listed on the Pakistan Stock Exchange during 2019-20. The dependent variable was EM, measured using discretionary accruals.

Results: Our research uncovered a clear link between board independence and earnings management, revealing that companies with a greater proportion of independent directors on their boards displayed a decreased tendency to engage in earnings management. Furthermore, our study revealed a negative connection between the effectiveness of audit committees and earnings management, indicating that firms with more efficient audit committees were less inclined to resort to earnings management practices.

Practical implications: It has implications for policymakers, regulators, and practitioners in promoting better CG practices and enhancing transparency in financial reporting.

Conclusion: The study provided evidence that CG mechanisms such as board independence and audit committee effectiveness play an important role in reducing EM in non-financial sector of Pakistan and firms with better CG practices were less likely to engage in EM that improved the transparency and reliability of financial reporting.