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Association between earnings management and properties of independent audit committee

members

S. Mitchell Williams
Singapore Management University

Contact Details:
Please Address All Correspondence To:
S.Mitchell Williams
Associate Professor of Accountancy
Singapore Management University
#05 11, 469 Bukit Timah Road
Singapore 259756
Phone: +65-6822-0609
Fax: +65-6822-0600
Email: mitchellw@smu.edu.sg
Key Words: Earnings management; corporate governance; audit committee; Singapore
JEL Classification: K0; G3; M4
Abstract:
This study empirically examines the association between three properties of independent audit
committee members that could impair or enhance the committees ability to constrain earnings
management. The three properties are: (1) presence of a professional independent audit
committee member (hereafter Pro-AC member); (2) extent of familiarity between independent
audit committee members and the external auditor (hereafter AC-External Auditor Familiarity);
and (3) presence of an interlocked independent director on the audit committee. Empirical
analysis is based on a sample of 465 Singapore publicly traded firm-years for 2000 2001. After
controlling for other possible determinants of abnormal accruals and audit committee
composition, I find the magnitude of abnormal accruals is more highly manifested amongst
Singapore publicly traded firms with audit committees comprising a Pro-AC member. Also, I
present evidence of a significant negative association between AC-External Auditor Familiarity
and the magnitude of abnormal accruals. Results do not indicate an association between AC-
Directorate Interlocks and the magnitude of earnings management. Overall, findings imply an
audit committee (i) engaging a Pro-AC member and/or (ii) more extensive AC-External
Auditor Familiarity is less effective in constraining earnings management. Results are robust to a
string of sensitivity tests including alternative proxies for earnings management, independent
variable and control factors.

Acknowledgements:
I appreciate the helpful comments on various versions of this paper by Greg Tower, Phil
Hancock, Stephen Courtenay, Phil Beaulieu, Michael Wright, Hussein Warsame, Duncan Green
and workshop/seminar participants at University of Calgary (Canada), Nanyang Technological
University (Singapore), Singapore Management University (Singapore), Hong Kong Polytechnic
University (Hong Kong), City University of Hong Kong (Hong Kong) and Curtin University of
Technology (Australia). I grateful acknowledge the financial support of the Wharton-SMU
Research Center and School of Accountancy, Singapore Management University. Any errors in
this paper are my own.

~ Please Do Not Quote Without Permission ~


Association between earnings management and properties of independent audit committee
members

Key Words: Earnings management; corporate governance; audit committee; Singapore


JEL Classification: K0; G3; M4
Abstract:
This study empirically examines the association between three properties of independent audit
committee members that could impair or enhance the committees ability to constrain earnings
management. The three properties are: (1) presence of a professional independent audit
committee member (hereafter Pro-AC member); (2) extent of familiarity between independent
audit committee members and the external auditor (hereafter AC-External Auditor Familiarity);
and (3) presence of an interlocked independent director on the audit committee. Empirical
analysis is based on a sample of 465 Singapore publicly traded firm-years for 2000 2001. After
controlling for other possible determinants of abnormal accruals and audit committee
composition, I find the magnitude of abnormal accruals is more highly manifested amongst
Singapore publicly traded firms with audit committees comprising a Pro-AC member. Also, I
present evidence of a significant negative association between AC-External Auditor Familiarity
and the magnitude of abnormal accruals. Results do not indicate an association between AC-
Directorate Interlocks and the magnitude of earnings management. Overall, findings imply an
audit committee (i) engaging a Pro-AC member and/or (ii) more extensive AC-External
Auditor Familiarity is less effective in constraining earnings management. Results are robust to a
string of sensitivity tests including alternative proxies for earnings management, independent
variable and control factors.

2
1. Introduction

This study empirically examines the association between three properties of independent audit

committee members and the magnitude of abnormal accruals 1 (proxy for earnings management2)

across a sample of 465 Singapore publicly traded firm-years. The three properties are: (1)

presence of a professional independent audit committee member serving on the audit committee

(hereafter Pro-AC member); (2) extent of familiarity between independent audit committee

members and the external auditor (hereafter AC-External Auditor Familiarity); and (3) presence

of interlocked independent directors on the audit committee (hereafter AC-Directorate

Interlock). After controlling for other possible determinants of abnormal accruals and audit

committee composition, I find the magnitude of abnormal accruals is more highly manifested

amongst Singapore publicly traded firms with audit committees comprising a Pro-AC member.

Also, I present evidence of a significant negative association between AC-External Auditor

Familiarity and the magnitude of abnormal accruals. Results do not indicate an association

between AC-Directorate Interlocks and the magnitude of earnings management. Overall,

findings imply an audit committee (i) engaging a Pro-AC member and/or (ii) more extensive

AC-External Auditor Familiarity is less effective in constraining earnings management.

One of the most frequently cited firm performance measures, earnings are strongly recognized for

conveying information to investors (LuCharme et al., 2003). Consistent with prior literature

1
Peasnell et al., (2000) argue two major categories of earnings management measures exist: (a) real
operating decisions such as asset sales (Black et al., 1998; Bartov, 1993) or changes in research and
development expenditure (Bushee, 1998; Bange and DeBondt, 1998); and (2) pure financial accounting
decisions such as accrual selection (McNicholas and Wilson, 1988) and accounting policy choices (Watts
and Zimmerman, 1986). As Peasnell et al., (2000, p.421) argue, costs of utilizing pure financial accounting
decisions to manage earnings are likely to be less than the costs of resorting to sub-optimal operating
decisions to boost reported performance. As earnings are the focus of this study, I use a proxy that best
reflects and captures corporate managements opportunistic behavior to temporarily adjust earnings.
2
Earnings management is defined as occurring 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 to influence contractual outcomes that depend on reported
accounting numbers (Healy and Wahlen, 1999, p. 369).

3
(e.g.Healy and Wahlen, 1999; Leuz et al., 2003), I argue incentives arising, in part, from the

conflict of interest between a firms insiders (i.e., corporate management) and outsiders (i.e.,

shareholders, creditors) entice corporate management to misrepresent firm performance via

earnings management. To constrain earnings management, regulators, scholars and other relevant

stakeholders stress the increasing need for sound corporate governance practices and

mechanisms. The audit committee is presently touted as a principal internal corporate governance

mechanism for constraining earnings management (Blue Ribbon Committee 1999; Corporate

Governance Committee 2001; Dey 1994; New York Stock Exchange and National Association of

Securities Dealers 1999; Securities and Exchange Commission 1999). The general undertone of

prior discussion and debate suggests independence3 is a central determinant of the audit

committees effectiveness when constraining earnings management. This presumption remains an

open empirical question, however, with few studies conducted. Also, data in prior research is

drawn from a single one domestic setting (e.g.Klein, 2002; Chtourou et al., 2001). It is

questionable if empirical findings based solely on United States data are readily generalizable

universally to other domestic settings. For purposes of this study I accept, in principle, the

aforementioned presumption. However, I propose properties of independent directors may

enhance (impair) audit committee independence, thereby, increasing (decreasing) the committees

ability to constrain earnings management.

The study provides a significant contribution to the corporate governance literature broadening

our understanding of the association between audit committee independence and earnings

management beyond the current general fixation with the proportion of independent directors on

3
. Several definitions of audit committee independence exist. One definition infers an audit committee is
independent if the majority of committee members are independent of corporate management (eg., Dechow
et al., 1996; Beasley and Salterio, 2001; Klein, 2002). Singapore regulations follow this definition Some
(eg., NASDAQ, 1999; NYSE, 1999) suggest audit committees only function independently if all members
are not influenced by management. A third, and the most common interpretation in the literature, defines of
audit committee independence to be proportional to the percentage of independent directors on this
committee (e.g., Beasley, 1996). Third study adopts the latter perception of independence.

4
the committee. Specifically, I document the first-large scale empirical analysis of the impact

fundamental properties of independent directors that enhance or compound audit committee

independence and, subsequently, the quality of earnings. Results have implications for various

parties. For example, findings infer regulators striving to improve audit committee effectiveness

may need to balance recommendations audit committees be composed of a higher proportion of

independent directors against properties of independent director available to serve this committee.

This study also makes other notable contributions. For example, I advance the international

understanding of audit committees earnings management links. In conjunction, I provide

additional evidence determining if propositions (with their foundations in the Anglo-American

model of corporate governance and heritages in the United States or United Kingdom) for

improving corporate governance are universally applicable to other domestic settings. These

findings are important for establishing the extent to which corporate governance practices can be

harmonized across national boundaries. Finally, I contribute to the growing earnings management

literature using data lacking patterns of a priori systematic upwards or downwards earnings

management. The majority of prior earnings management research examines firms with specific

incentives for overstating earnings or committing egregious financial fraud (Beasley 1996;

DeFond and Jiambalvo 1994; Parker 2000). Using a sample without a pattern of a priori

systematic upwards or downwards earnings management assist to generalize findings across a

wider set of business conditions.

Examination of audit committees from Singapore publicly traded entities offers several

advantages. First, Singapores corporate governance model is generally based on the Anglo-

American model. Hypotheses with their inherent foundation developed in the United States and

United Kingdom, therefore, can be developed to encompass Singapore. Second, analysis of audit

committee issues in Singapore is both prudent and timely. Though Singapores underlying

corporate governance system mirrors that of various Western economies, contrasts exist. For

5
example, Singapore lacks many effective market mechanisms such as strong take-over market

or bank centered monitoring system to monitor corporate management. There is greater

reliance, therefore, on internal control mechanisms including audit committees. Indeed, for more

than a decade audit committees have been a prominent feature of Singapores corporate

governance landscape. Thus, its role is well understood and developed within the Singapore

business environment. Meanwhile, recent reforms continue to stress and strengthen the audit

committees role in Singapore publicly listed firms. These reforms, however, have been

implemented without the support of substantive empirical research. Third, Singapore provides a

lucrative domestic setting for empirically analyzing earnings management concerns. Leuz et al.,

(2003) report, relative to the United States, earnings management is considerably more

pronounced in Singapore.4 Finally, I am able to collect data from the vast majority of

economically significant Singapore publicly listed firms.

Empirical findings are subject to several caveats. First, earnings management is difficult to

measure. To address this concern I use several proxy measures for earnings management.

Empirical results are robust to sensitivity tests using alternative proxies. Second, though sharing a

common corporate governance infrastructure (socio-political characteristics) with various

Western (Asian) nations, the single-nation focus of this study may weaken the ability to

generalize results. Therefore, caution applies when interpreting findings within a broader

international setting. Third, I acknowledge other internal control mechanisms, that could be

complementary, may influence corporate managements decision to manage earnings. It is

difficult to fully control for the potential impact of all other internal control mechanisms, or to

disentangle them completely from the influence of audit committee properties. Whilst I include

relevant control factors, and conduct a battery of various sensitivity tests, other endogenous

4
Leuz et al., (2003) study covers 31 nations. The United States forms the benchmark being the nation with
the lowest aggregate earnings management score. Comparatively, Singapore ranked eighth highest nation
for earnings management.

6
interactions could still exist. Finally, I examine cross-sectional associations only, not causation

relationships.

The remainder of this study is structured as follows. In Section 2 I discuss incentive underscoring

earnings management and the role of audit committees. I also develop the testable hypotheses in

this section. In Section 3 I describe research test procedures including sample selection and proxy

measures for earnings management, independent variables and control factors. Main empirical

results are outlined in Section 4. Sensitivity tests are described in Section 5. The final section

provides a summary of findings, contributions, limitations and ideas for future research.

2. Background and Hypotheses Development

2.1 Earnings Management and Role of Audit Committees

Globally earnings are increasingly used by shareholders in contractual arrangements with

corporate management either directly (i.e., basis for awarding bonuses) or indirectly (i.e.,

reference point for activating stock option awards). Earnings also act as a pivotal element in the

formation of capital market expectations and stock price valuation. Further, capital providers rely

heavily on earnings when making lending decisions. Finally, governments and regulatory

authorities may use earnings as a triggering barometer for the development (activate) of new

(existing) anti-monopoly and other legislative regulations.

Earnings, both positive and negative, can adversely affect corporate managements self-interests

prompting potential conflicts with outsiders. Poor earnings, for instance, may generate

unfavorable wealth consequences with bonuses reduced and stock options unrewarded. Earnings

below capital market expectations could lead a decline in a firms share price prompting

7
shareholders to demand management replacement. 5 Finally, a history of poor earnings may harm

a managers reputation capital reducing potential future employment opportunities. Whilst

positive earnings enhance corporate managements wealth, amounts perceived as excessive may

draw unwanted attention. For instance, perceived excessive positive earnings (whether in fact or

not and if unexpected) may prompt allegations of: (a) attempts to artificially influence capital

markets; (b) erroneous financial reporting practices; or (c) fraudulent behavior. If allegations

influence views of investors, shareholders and capital providers, corporate managements

reputation capital may suffer. Also, charges of industry monopolization could evolve prompting

regulators to adjust or introduce regulations and rules aimed at improving competition and

prevent price-gouging. Extra regulatory intervention and scrutiny could negatively affect a firms

stock price leading to shareholder dissatisfaction and threats of corporate management change.

In summary, corporate management may be enticed by various incentives to manipulate reported

earnings either upwards or downwards. The accounting and corporate governance literatures

document different internal governance mechanisms and external market forces that can

discipline corporate management. Boards of directors are often cited as the primary internal

monitoring governance mechanism. Fama (1980, p.290), for example, argues the board of

directors is a market-induced institution, the ultimate internal monitor of the set of contracts

called a firm, whose most important role is to scrutinize the highest decision makers within the

firm. Whilst boards of directors are designated the overarching responsibility for monitoring

corporate management, audit committees are increasingly defined as the pivotal standing

committee accountable for overseeing the quality of a firms financial reporting system, including

reported earnings. The Security Exchange Commission (1999, p.1), for instance, comments an

audit committee plays a critical role in the financial reporting system by overseeing and

monitoring managements and the independent auditors participation in the financial reporting

5
Weisbach (1988), for example, finds senior management turnover increases with poor reported earnings.

8
process.audit committees can, and should, be the corporate participant best able to perform that

oversight function. Audit committees perform other significant functions. Pincus et al., (1989),

for example, argue audit committees provide an important avenue for communication between

the external auditor and shareholders. Via regular meetings with the external auditor the audit

committee develops a greater understanding of the firms financial reporting process; thereby,

enhancing the quality of information provided to shareholders (Beasley and Salterio 2001; Pincus

et al. 1989). The audit committee can also act as the principal arbitrator during conflicts between

the external auditor and corporate management. Finally, audit committees play a crucial role in

the constraining earnings management. Klein (2002, p. 378), for example, comments a central

role of audit committees are to reduce the magnitude of positive or negative abnormal accruals.

Independence is considered a quintessential quality determining audit committee effectiveness.

Preoccupation with independence is strongly reflected in the discussions and recommendations of

various recent international corporate governance reports. Stock exchanges and regulatory

agencies internationally have adjusted regulations to emphasis a greater need for audit committee

independence. A natural conclusion of accepting the importance of independence to audit

committee effectiveness is increased independence reduces the magnitude of earnings

management (either positive or negative). Despite the significant of this assertion it is the focus of

scant empirical research. Seminal work by Klein (2002) based on a sample of 692 publicly traded

United States firm-years indicates the magnitude of abnormal accruals to be more pronounced

for firms with audit committees comprised of less than a majority of independent directors

(p.376). Klein (2002), however, also reports no significant difference in abnormal accruals of

firms with audit committees comprised solely of independent directors and those without.

Meanwhile, Chtourou et al., (2001) find a negative association between income increasing

earnings management and the proportion of independent directors on the audit committee. Again,

findings are based on United States data (300 firm-years).

9
In principle, I accept the assertion of a negative (positive) association between independent (non-

independent) audit committees and the magnitude of earnings management. However, I argue that

to fully understand the ramification of the aforementioned association one must extend the

analysis beyond the simply notion audit committee effectiveness is merely a function of higher

independent directors representation. I propose properties pertaining to independent directors may

intercede to enhance or impair the extent of an audit committees independence and its overall

effectiveness. In the following subsections I develop hypotheses to test the influences of three

audit committee properties on the magnitude of earnings management.

2.2 Presence of Pro-AC Member

Regulators, stock exchanges and other relevant institutional bodies internationally are adjusting

regulations placing more stringent requirements on firms to compose audit committees with

independent directors possessing specialized skills, and corporate governance and financial

knowledge. A by-product of new and/or additional rules stipulating specialized skills, and

corporate governance and financial knowledge is a reduction in the human-resource pool of

individuals qualified to sit on audit committees. Rapidly expanding capital markets in nations

such as Singapore place extra constrains on this human-resource pool. This is because incumbent

firms face greater competition to acquire (or retain) the servings of qualified independent

directors. A low natural population6 further perpetuates the pressure on firms. As the human-

resource pool diminishes, qualified human-resource actors recognizing the constraints of firms

may perceive it as greater opportunities to derive a higher proportion of their annual income from
6
For instance, in Singapore and United States at the end of 2001there were approximately 400 and 15,000
publicly listed firms. Assuming 3 members per audit committees, the number of audit committee positions
in Singapore and United States is 1,200 and 45,000 respectively. For illustration assume 20 percent of a
nations overall population constitutes the human resource pool for audit committee members. Based on
this percentage the ratio of qualified individuals capable of serving on the audit committee to number of
audit committee positions is approximately 1,100:1 in the United States and 550:1 in Singapore.

10
simultaneously holding numerous boards of director and audit committee positions. 7 I term

individuals devoting considerable time and effort to serving concurrently on a substantial 8

number of boards of directors and audit committees as an independent director, such that these

commitments may constitute a sizeable proportion of their annual income, a Pro-AC member.

Prior empirical research does not address the impact of Pro-AC member presence on audit

committee effectiveness and ultimately earnings management. I surmise arguments supporting

either a positive or negative association between the presence of a Pro-AC member on the audit

committee and the magnitude of earnings management exist.

Consistent with a negative association, corporate governance advocates, regulators and scholars

argue an independent directors effectiveness declines when serving on too many 9 boards of

directors. This is because they cannot adequately discharge their fiduciary duties. Empirical

findings support this view. Core et al., (1999), for example, find a positive association between

CEO compensation and boards comprising individuals serving simultaneously on a number of

corporate boards. If, by definition, a Pro-AC member sits on too many boards and audit

committees their ability to effectively discharge their responsibilities is likely to be impaired.

Consequently, the capacity of an audit committees to constrain earnings management may

decline. Cultural dimensions and ownership structure may influence firms to focus (or assign

greater weightage) to reputation characteristics of individuals when seeking a person to serve as

an independent director on the board of directors and audit committee. For instance, in societies

with a heightened propensity for secrecy, strong power distance relationships and/or greater

7
Indeed, regulatory constraints, in conjunction with societal factors in societies (such as Singapore) with a
higher propensity for secrecy and high levels of family-owned firms, may increase the likelihood of some
individuals acting full-time within the capacity of an independent director sitting on numerous boards of
directors and audit committees at the same time.
8
Based on NACD (1996) and Blue Ribbon Commission recommendations, a cut-off point for substantial
would be individuals holding three or more (six or more if retired) board and audit committee positions
simultaneously. For this study, however, I apply a minimum cut-off of five. See Section 3.3.
9
NACD (1996) and Blue Ribbon Commission (1999) recommendations suggest individuals sit on too
many boards of directors if holding three or more (six or more if retired) positions simultaneously.

11
prevalence of family-owned firms, there is likely to be a greater desire to restrict information to

insiders. Thus, firms in such societies may place additional attention to identifying and appointing

individuals with a reputation for being management-friendly as they are likely to be more

supportive of restricting information from outsiders. If having a reputation for being

management-friendly is a contributing factor for why an independent director (such as a Pro-

AC member) serves simultaneously on a high number of boards of directors and audit

committee, this would infer the independence of these individuals (and boards of directors and

audit committees) is impaired. Finally, as a Pro-AC member is likely to have greater experience

and knowledge of audit committee matters a firm may substitute their presence for other internal

control mechanisms. If Pro-AC member presence merely complements other internal control

mechanism, any substitution stemming from the presence of such individuals on the audit

committee could weaken a firms overall internal control structure increasing the opportunities

for more expansive earning management.

I propose two lines of reasoning supporting a positive association. First, with substantial time and

effort devoted to discharging their fiduciary duties for a number of firms, opportunities for a Pro-

AC member derive income from alternative sources is reduced. With such a large personal

financial stake at risk, there is considerable incentive for a Pro-AC member to ensure audit

committee independence is preserved and the committee performs its respective roles

satisfactorily (if not above expectations). This is because a Pro-AC member would seek to

protect reputation capital, and maintain present and future directorships, and income streams.

Opportunities for earnings management, therefore, are likely to decline. Second, individuals

such as a Pro-AC member with experience sitting on various boards of directors and audit

committee will naturally have more extensive intimate knowledge and understanding of corporate

governance matters, and audit committee roles and functions. Intuitively (and consistent with the

views of corporate governance reformists and proclamations of regulators and institutional

12
bodies), therefore, appointment of more experience individuals should increase the audit

committees overall monitoring effectiveness and ability to constrain earnings management.

As the association between Pro-AC member presence and the magnitude of earnings

management cannot be determined a priori, I, propose the following null hypothesis:

Hypothesis 1: There is no significant difference in the magnitude of earnings management (as


measured by abnormal accruals) between firms with at least one Pro-AC member present on the
audit committee and those without.

2.3 Level of AC-External Auditor Familiarity

The notion of familiarity is described in the prior literature as being encased within the length of

tenure between a firm and the external auditor. Length of tenure is viewed to have a positive

association with familiarity. Some corporate governance reformists and scholars argue greater

familiar resulting from longer firm-external audit links impairs auditor independence as the

chances of collusion and inadequate discharge of the external auditors responsibilities intensify.

It is recommended external auditors be regularly rotated. I advocate familiarity can also exist

between independent audit committee members10 and the external auditor. At a basic fundamental

level I suggest such familiarity arises when an audit firm is the same client of two different firms

with at one individual sitting simultaneously on each firms audit committee. I further surmise

familiarity intensifies if the partner-in-charge is also the same individual.

I propose familiarity between independent audit committee members and the external auditor

could have positive or negative implications on the audit committees effectiveness in

10
Relationships between executive directors and the external auditor are also likely to evolve. However,
these are likely to depend on different motivating factors. For instance, an executive director may be
concerned the external auditor recommends changes to a firms financial statements that affect bonuses.
Such financial and monetary concerns are less likely to concern independent directors. Overall, the impact
of familiarity on audit committee effectiveness is likely to be of greater when consider independent director
external auditor relationships.

13
constraining earnings management. A positive influence may result because as familiarity

increases an independent audit committee members knowledge, understanding and appreciation

of the external auditors policies and practices accumulates. The independent audit committee

member is then better placed to recommend streamlining of audit committees procedures to

better assist the committee to focus on aspects of the financial reporting process not adequately

addressed in the external audit. By concentrating scrutiny to specific areas of risk, rather than

spreading finite resources too thinly, the audit committee will be better able to constrain earnings

management. Greater familiarity may also influence the audit committees role as an arbitrator

during conflicts between corporate management and the external auditor. Antle and Nalebuff

(1991) and Dye (1991) note audited financial statements are ultimately the result of negotiations

between corporate management and the incumbent auditor. Independent audit committee

members are supposedly, by definition, impartial. Nonetheless, human nature cannot be fully

discounted. Greater familiarity may heighten an independent audit committee member confidence

in the recommendations of external auditor. Thus, during conflicts an independent audit

committee member may be more inclined to support the external auditor rather than corporate

management. In giving greater support to the external auditor there is likely to be less scope for

corporate management to manage earnings.

I note above greater knowledge and understanding of the external auditors procedures and

practices stemming from familiarity may improve audit committee effectiveness However, the

opposite occur because additional knowledge may prompt complacency stemming from an over

confidence and appreciation of the external auditors abilities and coverage. Confident the

external auditor will adequate discharge their audit responsibilities, the independent audit

committee may substitute or forsake some of the own monitoring responsibilities so as to attend

to other firm (or even personal) matters. Under these circumstances, the risk earnings

management will remain undetected increases. Familiarity could also promote collusion. The

14
audit committee is in principle the body responsible for recommending which external audit firm

to appoint. An independent audit committee member of two firms with the same external auditor

may be hesitant to recommend an alternative auditor for Firm A if this prompts Firm B to

question the individuals integrity and competence in recommending the original external auditor

be appointed to audit it (i.e., Firm B). A recommendation for a change of auditor could be

interpreted as a mark against the independent audit committee members reputation capital. To

avoid a fall in their reputation capital, the independent audit committee member of both firms

may implicitly collude with the external auditor to minimize the risk and reasons (such as

excessive conflict between corporate management and the external auditor) for change. By

colluding in this manner the directors independence and by association the audit committee

is potentially impaired leading to greater opportunities for earnings management.

Given the opposing arguments I propose the following null hypothesis:

Hypothesis 2: There is no significant difference in the magnitude of earnings management (as


measured by abnormal accruals) between firms with greater AC-External Auditor Familiarity
and firms without AC-External Auditor Familiarity.

2.4 AC-Directorate Interlock Influences

The concept of directorate interlocks is more established in the literature. Part of a broader study

of managerial elites and corporate governance (Pettigrew, 1992; Roy, Fox and Hamilton, 1994),

directorate interlock concerns were first articulated in the United States as early as 1913 by

Brandeis. Scholarly interest and research is initially grounded in the work of Florence (1961) in

the United Kingdom and Dooley (1969) in the United States. Agency theory provides the

underlying theoretical underpinnings of one major stream of directorate interlock research. 11


11
Resource-dependence theory is the major theoretical basis of a second stream of research. Research
within this second stream focuses on the strategic value and benefit of directorate interlocks in promoting
organizational survival and success through the ability to control the flow of resources (e.g.Pfeffer and
Salancik, 1978; Mizruchi, 1982; DiMaggio and Powell, 1983). As I concentrate on contractual relationships
I confine my discussion to agency theory.

15
Agency theorists generally postulate possible major outcomes of directorate interlocks include the

promotion of upper-class collusion and a shift in the decision-making process of boards of

directors in favour of corporate management. In the specific context of audit committees, the

presence of an interlocked independent director is likely to reduce the committees

independence. Consistent with prior literature (e.g.Core et al., 1999) I define an independent

director to be interlocked if an executive director on the corporate board of Firm A (on which

the independent director sits) is also a member of the corporate board of Firm B (to which the

independent director is employed). Agency theorists argue that where interlock arrangements

exist the independent director is less likely to support Firm As board decisions with negative

implications for the executive directors self-interests. Reluctance arises because the executive

can influence board decisions of Firms B; thus, the interests of the independent director.

Empirical research, however, yield inconclusive findings. Core et al., (1999), for example, find

the association between directorate interlocks and CEO compensation to be positive though

statistically insignificant from zero. Findings are consistent with Hallock (1997).

Despite continued interest amongst corporate governance reformists, institutional bodies and

scholars,12 the association between interlocked independent director presence on the audit

committee and earnings management is yet to be empirical tested. Following established agency

theory arguments I surmise interlocked independent director presence on the audit committee

will compromise the committees independence. Therefore, opportunities for earnings

management are likely to increase. To test this proposition I form the following hypothesis:

Hypothesis 3: There is a positive association between the magnitude of earnings management (as
measured by abnormal accruals) and the extent of interlocked independent director presence on
the audit committee member.

3. Data Description

12
Blue Ribbon Committee (1999) guidelines, for example, urge firms to minimize directorate interlocks.

16
3.1 Sample Selection

The initial sample comprises 875 firm-years representing all publicly traded entities listed on the

Singapore Stock Exchange (SGX) as of January 1, 2000 and 2001 and holding annual shareholder

meetings between April 1, 1999 and March 31, 2002.13 I eliminate 59 (2000) and 83 (2001) firm-

years of new firm listings as there is insufficient details to calculate the proxy for earnings

management.14 Firm-years of delisted entities are also eliminated (13 (2000) and 25 (2001)).

Consistent with prior empirical research I remove firm-years of: (a) non-Singaporean domiciled

publicly traded entities (26 (2000) and 25 (2001)); and (b) financial industry sector entities 15 (29

(2000) and 24 (2001)). I use the cross-sectional Jones (1991) regression model to calculate the

earnings management proxy. Model parameters are estimated by industry (as specified by the

SGX) classification. Consistent with prior literature (Klein 2002) I stipulate estimates be based on

a minimum of eight observations for each industry sector. Consequently, 81 firm-years (53 (2000)

and 28 (2001) are excluded. Earnings management proxy calculation data is hand-collected from

1999, 2000 and 2001 fiscal year annual reports. Where annual reports are unavailable data is

extracted from the Datastream Active and Research files. Data for 32 firms (18 (2000) and 14

(2001)) could not be collected; therefore, corresponding firm-years are eliminated. Data for

corporate governance proxy measures of the independent variables is obtained from the

Singapore Corporate Governance Intellectual Capital (CGIC) Database. Despite its

comprehensive coverage corporate governance data for 19 firm-years (15 (2000) and 4 (2001))

could not be satisfactorily determined. These firm-years are subsequently removed. Finally, I

13
At the start of January 1, 2000 (2001) there were 410 (465) publicly listed firms on the SGX.
14
Prior research suggesting a positive association between IPOs and earnings management provides
additional support for exclusion of these firm-years. Eliminating firm-years of IPOs in their initial year of
listing assists reduce the undue influence of this factor.
15
Difficulties measuring total accruals and abnormal accruals amongst financial industry sector entities
warrant such exclusion (e.g.Klein, 2002; Peasnell et al., 2000). Financial industry sectors include banks,
insurance companies, stock brokerages and financial advisor firms.

17
exclude 13 outlier (>5 standard deviations from the dependent variables mean) firm-year (8

(2000) and 5 (2001). The final useable sample comprises 465 firm-year observations. Table 1

Panel A summaries by year the construction of the final useable sample. An industry breakdown

is reported in Table 1 Panel B.

[Take in Table 1 About Here]

3.2 Proxy for Earnings Management

Consistent with some prior literature (DeFond and Park 1997; Klein 2002) I use both negative

and positive abnormal accruals as both can be used to conceal poor performance or save present

earnings for future use. Prior to estimating abnormal accruals I calculate total accruals (hereafter

TAC) for firm k in year t as the change in non-cash current assets less the change in operating

current liabilities less depreciation and amortization expenses. TAC is formally defined as:

TACjt = (CAjt - Cashjt) (CLjt - LTDjt - ITPjt) - DPAjt (1)

Where:
TACjt = total accruals for firm k in time period t;
CAjt = change current assets for firm k from time period t-1 to t;
Cashjt = change cash balance for firm k from time period t-1 to t;
CLjt = change current liabilities for firm k from time period t-1 to t;
LTDjt = change long-term debt included in current liabilities for firm k from time period t-1 to t;
ITPjt = change income tax payable for firm k from time period t-1 to t; and
DPAjt = depreciation and amortization expense for firm k from time period t-1 to t.

I then decompose TAC into normal accruals (hereafter NAC) and abnormal accruals (hereafter

ACC) using the cross-sectional Jones (1991)16 model defined formally as:

TAC jk,t / TAjk,t-1 = j,t [1/ TAjk,t-1] +j,t [REVjk,t / TAjk,t-1] + j,t [PPEjk,t / TAjk,t-1] + jk,t (2)

16
Dechow et al., (1995) propose a modified cross-sectional Jones (1991) model. Previous studies,
however, show the original and modified cross-sectional Jones (1991) models yield almost identical
results (eg. Kothari et al., 2001; Klein, 2002). For completeness I calculate abnormal accrual estimates
using the modified cross-sectional Jones (1991) model (see Section 6.1 Sensitivity Analysis). I find
statistically insignificant differences. As the papers major objective is not test different models the main
results are reported using the original cross-sectional Jones (1991) model.

18
Where:
TAC jk,t = total accruals for firm k in industry j in year t;
TAjk,t-1 = are total assets for firm k in industry j at the end of year t-1;
REVjk,t = change net sales for firm k in industry j between years t-1 and t;
PPEjk,t = gross property, plant and equipment for firm k in industry j in the year t;
j, j, j = industry specific estimated coefficients; and j = error term.

NAC is defined as the fitted values from Equation (2) whilst ACC is the residual (i.e., the

difference between TAC and NAC). ACC is defined formally in Equation (3):

ACCij,t = TAC jk,t / TAjk,t-1 - { j,t [1/ TAjk,t-1]+j,t [REVjk,t / TAjk,t-1] + j,t [PPEjk,t / TAjk,t-1]} (3)

Where:
j,t j,t j,t are the fitted coefficients from Equation 2.

Overall, I calculate 30 industry-year combinations from the final useable sample. The maximum

number of observations for a given industry-year combination is 29 (commerce wholesale in

2001). The mean (median) estimation portfolio size is 16 (14) observations.

Several reasons support using the cross-sectional Jones (1991) model. First, it is used regularly in

prior earning management research (Becker et al. 1998; DeFond and Jiambalvo 1994; DeFond

and Subramanyam 1998; DuCharme et al. 2000; Guidry et al. 1999; Klein 2002; Teoh et al.

1998a; Teoh et al. 1998b). Second, prior research concludes this model performs best in detecting

abnormal accruals. Bartov et al., (2000), for example, conclude it is the only model consistently

able to detect earnings management for a sample of firms receiving audit qualifications. Third,

relative to the time-series Jones (1991) model, the cross-sectional variant overcomes (a) the

survivorship bias present in the times-series model and (b) eliminates the assumption parameter

estimates remain stable over time (Bartov et al. 2000; Jones 1991).17 Finally, the capital market in

Singapore is relatively small relative to the United States and the United Kingdom. It important,

therefore, to use a method that for statistical purposes maximizes sample size.

17
A disadvantage of the cross-sectional Jones (1991) model is it ignores to some degree the reversal of
abnormal accruals from previous periods; thus, power of empirical tests to detect earnings management
may be reduced (Peasnell et al., 2000).

19
3.3 Independent Variables18

Presently, no formal definition of a Pro-AC member exists. In developing an operational

definition I follow recent NACD (1996) and Blue Ribbon Commission (1999) guidelines as

utilized by Core et al., (1999) for direction. However, I apply a narrow definition than outlined in

the aforementioned guidelines for distinguishing someone sitting on a high number of boards of

directors. Specifically, I define a Pro-AC member as an individual: (a) serving simultaneously

on 5 or more boards of directors as an independent director; and (b) an audit committee member

on at least 80% of those corporate boards. I feel this narrow definition is a more systematic and

concerted, better capturing individuals with a sizeable investment to being an independent

director on various corporate boards and audit committee. Also, this definition sifts out

individuals serving on multiple boards but have little or limited role in audit committee

responsibilities. The CGIC Database for Pro-AC members in 2000 and 2001 based on the

aforementioned definition. Firm-years having corresponding audit committee upon which at least

one Pro-AC member preside are coded one, all others zero. The dichotomous proxy is

designated ProfAC.

I create a two-fold criterion for scoring AC-External Auditor Familiarity. First, I assign a value

of 1.0 for each of the following conditions met:

1. at least one independent directors on the audit committee sits simultaneously on the audit

committee of another firm as an independent director with the incumbent external auditor

for both firms being identical; and

18
Empirical findings for the independent variables are based on contemporaneous data. Several reasons
justify use of contemporaneous data: (1) no formal theoretical justification supporting use of
contemporaneous data versus lagged; (2) prior related research generally relies on contemporaneous data
(Klein 2002; Peasnell et al. 2000); and (3) a data review suggests audit committee and board of director
composition and structure of Singapore publicly listed firms remained stable for during the analysis period.
For completeness, however, I also perform sensitivity tests using lagged data (see Section 6.4).

20
2. Condition (1) is met and partner-in-charge of both audits same individual.

A firm-year where all conditions are satisfied receives a score of 2.0 (1.0 + 1.0), whilst those

meeting one receive a score of 1.0. Firm-years where none of the conditions are met receive a

score of 0.0. I denote this proxy measure ACAP Score.

Applying the aforementioned definition of an interlocked independent director, I screened the

CGIC Database for all individuals meeting this criteria that serve on audit committee. I then sum

the total number of interlocked audit committee members for each firm-year. Following Core et

al., (1999) totals are scaled by the total number of audit committee members. The resulting proxy

measure, represented as a percentage, is denoted AC-Locks.

3.4 Control Factors

Prior empirical research indicates earnings management and audit committee attributes may be

related to other confounding factors. Bartov et al., (2000) argue failure to control for confounding

factors could result in the false rejection of the null hypothesis that earnings management is

absent when the opposite is true. With regard to earnings management, prior research suggests a

negative association to political costs (Han and Wang 1998), executive directors ownership level

(Warfield et al. 1995), ownership structure (Rajgopal et al. 1999), auditor quality (Becker et al.

1998) and operating cash flow performance (Dechow et al. 1995). Also, previous findings suggest

a positive association to financial leverage (DeFond and Jiambalvo 1994) and the absolute change

in earnings from year t-1 to t (Bartov et al. 2000). In relation to audit committee features, Beasley

and Salterio (2001) and Klein (2002) report board size and the percentage of independent

directors are significantly positively influence audit committee composition. Firm size, duality,

market-to-book ratios and prior negative earnings are also found to have confounding effects on

audit committee properties. I include control factor proxy measures for the aforementioned

21
determinants of either earnings management or audit committee properties. Proxy measure

definitions and predicted directional relationships are summarized in Table 2.

[Take in Table 2 About Here]

4. Results

4.1 Descriptive Statistics

The mean (median) R-squared statistic for the 30 industry-year combinations calculated using the

cross-sectional Jones (1991) model is 35.74% (18.95%). Table 3 Panel A reports descriptive

statistics for TAC, ACC and absolute ACC (hereafter Abs(ACC)) with sample means (medians)

being -0.0697 (-0.0708), -0.0012 (0.0011) and 0.0657 (0.0524) respectively. Statistical tests to

determine if the mean ACC is significantly different from zero yields a t-statistic of 0.628 (p-

value = 0.714). Across the final useable sample, 30.23% of TAC and 55.53% of ACC values are

positive. A sign test yields a p value of 0.651 implying no systematic upward or downwards

earnings management activity. Consequently, consistent with prior research (Bartov et al. 2000;

Becker et al. 1998; Klein 2002; Warfield et al. 1995) I use Abs(ACC) as the proxy for combined

influences of income-decreasing and income-increasing earnings management.

Table 3 Panel B reports general descriptive data for key board of director and audit committee

composition features. Mean (median) board of director and audit committee membership is 7.10

(7.00) and 3.20 (3.00) respectively. Independent directors constitute on average 38.97% of board

of directors membership. This is lower than in Western economies such as the United States,

Canada and United Kingdom (Klein, 2002; Beasley and Salterio, 2002; Peasnell et al., 2000) but

comparable to Asian nations. Higher ownership concentration and family-owned firms in

22
Singapore may account, in part, for this finding. No board of directors is comprised solely of

independent directors. Furthermore, only 14.16% of the boards of directors have independent

directors in the majority.19 For audit committees, independent directors constitute on average

72.94% of the membership. All audit committees comprise a majority of independent directors;

however, only 18.24% comprise solely independent directors. Descriptive statistics of audit

committee composition is generally consistent with prior studies using data from Singapore or

Western nations20 (Beasley and Salterio 2001; Klein 2002).

[Take in Table 3 About Here]

Descriptive statistics of independent variables are shown in Table 3 Panel C. Findings show

34.30% of the final useable sample have at least one Pro-AC member on the audit committee.

Mean (median) number of audit committee positions held by each Pro-AC member individuals

is 5.43 (5.00). Comparatively, mean (median) number of audit committee positions held by all

individuals acting solely as an independent director and on at least one audit committee is 1.68

(1.39). The mean (median) ACAP Score for the final useable sample is 0.58 (0.00); 10.32%

receiving the maximum score of 2.0 and 37.63% scoring 1.0. The sample mean (median) of

interlocked independent audit committee members is 4.57 (6.10). At least one interlocked

independent director is present on audit committees of 11.47% of the final useable sample.

Table 3 Panel D reports basic descriptive statistics for the control factors. Consistent with

Singapores social and cultural background, both executive directors ownership and overall

ownership concentration are generally higher than in Western economies. Mean cash flow from

operations (0.061) is slightly lower than in the United Kingdom (Peasnell et al. 2000) and United
19
Percentage of independent directors exceeded the percentage of executive directors on the boards of
directors of only 34.95% of the final useable sample.
20
Long standing legal requirements for Singapore publicly traded firms to have a majority of members
being independent of corporate management is likely to account for these similarities.

23
States (Klein 2002). Sluggish economic conditions following the Asian economic crisis may, in

part, account for 17.49% of the sample firms reporting two or more years of consecutive net

losses. The mean (median) market-to-book ratio is $1.42 ($0.90). Big-Five audit firms are the

external auditor of 89.46% of the final useable sample firms. Finally, 76.35% (23.65%) of the

final useable sample firms are listed on the main board (SESDAQ) of the SGX.

4.2 Correlations

Table 4 presents Pearson pairwise correlations between the dependent variable, independent

variables and control factors.21 ProfAC and ACAP Score are positively and negatively correlated

with Abs(ACC) respectively. The correlation between AC-Locks and Abs(ACC), however, is not

significantly different from zero. Table 4 results also indicate Abs(ACC) is positively correlated

with, BoD Size (p<0.05) and Negative NI (p<0.01), and negatively correlated with Leverage

(p<0.05), Firm Size (p<0.01), Auditor (p<0.01), Ownership Concentration (p<0.01) and CFO

(p<0.01). Correlations between Abs(ACC) and (1) BoD Ind, (2) Duality, (3) ExeDirOwn, (4)

MV/BV and (5) ABS NI are not significantly different from zero. There are also some significant

correlations between independent variables and control factors with values not exceeding 0.500.

Farrar and Glauber (1967) argue bivariate correlation values above 0.8 indicate harmful levels of

mulitcollinearity (also see Hair et al., 1995). As a further test of multicollinearity variance

inflation factor (VIF) values are calculated (not tabulated for brevity). VIF values do not exceed

2.00, substantially below the critical value of 10.00 (Netter et al. 1989). Overall, multicollinearity

is deemed not to be a serious concern unduly affecting multiple regression analysis results.

[Take in Table 4 About Here]

21
Spearman pairwise correlations are also conducted producing similar results.

24
4.3 Multiple Regression Results

I use multiple regression analysis to test Hypotheses 1, 2 and 3. Table 5 Panels A, B, C and D

report results of four models (denoted Model I, Model II, Model III and Model IV) based on

Equation 4. In Model I, Model II and Model III a single independent variable (ACProf, ACAP

Score and AC-Locks respectively) and all control factors are included. For Model IV, all

independent variables and control factors are included simultaneously. This strategy highlights

each independent variables influence in both isolation and combination. Equation 4 is defined as:

Abs(ACC)i = ai + i1ACProfi + i2 ACAP Score i + i3AC-Locksi + i4BoD Sizei - i5BoD Indi +


i6Dualityi + i7% Exe Dir Owni + i8MV/BVi + i9ABSNIi + i10Negative NIi + i11Leveragei -
i12Sizei - i13Auditori + i14Owner Coni + i15CFOi + i (4)
Where:
i = firm-year 1 through 465; = coefficient for variables 1 through 15; = model residual; and
See Table 2 for formal definitions of the dependent variable, independent variables and control factors.

Model I, Model II, Model III and Model IV are all statistically significant. Model IV explains the

most variation in Abs(ACC) (21.9%) and Model III the least (20.3%). Coefficients on ACProf are

significantly positively associated with Abs(ACC) in Model I (p<0.05) and Model IV (p<0.05). In

comparison, coefficients on ACAP Score are significantly negatively associated with Abs(ACC) in

Model II (p<0.01) and Model IV (p<0.05). For AC-Locks, coefficients are positive but not

statistically significant in both Model III and Model IV. In summary, empirical findings presented

in Table 5 support rejection of Hypothesis 1, 2 and 3. Specifically, findings infer Pro-AC

member presence increases the likelihood of higher earnings management (both negative and

positive). Conversely, earnings management is less likely in firms with greater familiarity

between independent audit committee members and the external auditor. Finally, the magnitude

of earnings management is not significantly higher amongst firms with interlocked independent

directors serving on the audit committee relative to counterparts without.

25
[Take in Table 5 About Here]

Empirical findings also show Abs(ACC) is significantly negatively associated with Size (p<0.01),

Auditor (p<0.01) and CFO (p<0.01) , and significantly positively associated with Negative NI

(p<0.01) for Model I, Model II, Model III and Model IV respectively. MV/BV (p<0.05) is

significantly positively associated with Abs(ACC) though only in Model II and Model IV. Owner

Con (p<0.05) is also significantly positively associated with Abs(ACC) though only in Model III .

Finally, there is no statistically significant association between Abs(ACC) and (1) Board Size; (2)

BoD Ind; (3) Duality; (4) % Exe Dir Own; (5) ABSNI; and (6) Leverage across all models.

5. Sensitivity Tests

5.1 Alternative Proxies for Earnings Management

Inferences drawn in this paper are dependent on the use of abnormal residuals from the cross-

sectional Jones (1991) model being interpreted as a valid proxy for earnings management. I

perform additional tests to determine the robustness of these inferences. First, I re-estimate

abnormal accruals using the modified Jones (1991) model (change in revenue is adjusted for

changes in receivable) proposed by Dechow et al., (1995) and defined by Equation 5:

Abs(ACC) jk,t = TAC jk,t / TAjk,t-1

{ j,t [1/ TAjk,t-1] +j,t [(REVjk,t - RECjk,t)/ TAjk,t-1] + j,t [PPEjk,t / TAjk,t-1] + jk,t } (5)

Where:
RECjk,t = change in receivables for firm k in industry j between years t-1 and t.

Multiple regression analysis is then repeated. Table 6 Panel A reports an abbreviated summary of

findings (results for independent variable only). In general, Table 6 Panel A findings closely

mirror Table 5 results. It is noted, however, the association between Abs(ACC) and ACProf is

26
slightly weaker though still at p<0.05. Lack of significant discrepancies using either Jones (1991)

models is consistent with prior research (Klein 2002; Kothari et al. 2001).

[Take in Table 6 About Here]

The majority of earnings management research generally uses proxy measures for total accruals.

Peasnell et al., (2000, p.421), however, argue the working capital element of total accruals 22 is

potentially more appealing. Following the methodology of Peasnell et al., (2000), I estimate

Abs(ACC) using two working capital proxies based on Equations 6 and 7:23

Abs(ACC) jk,t = WCAC jk,t / TAjk,t-1

{ j,t [1/ TAjk,t-1] +j,t [(REVjk,t )/ TAjk,t-1] + j,t [PPEjk,t / TAjk,t-1] + jk,t } (6)

Abs(ACC) jk,t = WCAC jk,t / TAjk,t-1

{ j,t [1/ TAjk,t-1] +j,t [(REVjk,t - RECjk,t)/ TAjk,t-1] + j,t [PPEjk,t / TAjk,t-1] + jk,t } (7)

Where:
WCAC jk,t = working capital accruals ( non-cash current assets minus current liabilities) for
firm k in industry j in year t.

Table 6 Panel B and C report an abbreviated summary of findings (results for independent

variable only) of multiple regression tests performed with Abs(ACC) estimated based on

Equations 6 and 7. Again, results are similar to Table 5. Directional signs on coefficients of

independent variables and control factors are all consistent. A noted difference, however, is the

coefficient on ACProf is significant at p<0.10 rather than p<0.05. Also, explanatory power of

regressions reported in Table 6 Panels B and C are lower than those of Table 5. Overall, findings

based on working accruals support the robustness of Table 5 findings.


22
Peasnell et al., (2000) define total accruals as working capital accruals plus depreciation; hence, working
capital accruals is total accruals less depreciation. Some researchers (such as McNichols and Wilson, 1988;
Young, 1999; Beneish, 1998) argue working capital accruals focus on more judgmental items whilst
depreciation is a poor indicator of earnings management due to is visibility and rigidity.
23
Equation 6 uses the cross-sectional Jones (1991) model and Equation 7 the modified Jones (1991)
model. Peasnell et al., (2000) use only the modified Jones (1991) model. I estimate Abs(ACC) for
working capital accruals using both models for analytical completeness.

27
5.2 Increasing-Earnings and Decreasing-Earnings Incentives

As noted above, I use Abs(ACC) as the proxy for the combined influences of income-decreasing

and income-increasing earnings management as tests show no systematic upward or downwards

earnings management activity across the sample. Nonetheless, it could be argued income-

increasing and income-decreasing behavior is induced by different conditions and incentives that

could have different effects on factors influencing an audit committees effectiveness in

constraining management. Consequently, for analytical completeness, I partition the final useable

sample to perform sensitivity tests to address specific concerns related to income-increasing and

income-decreasing incentives. For partitioning I rely on the work of Kim et al., (2003). They

(Kim et al., 2003, p. 331-332) assume managers have income-increasing (income-decreasing)

incentives if the current periods performance relative to the benchmark performance (hereafter

current relative performance) is poor (good). Current relative performance is defined by Kim et

al., (2003, p.332) as the difference in CFO in year-t (scaled by lagged total assets) to the median

CFO performance of samples with year-t for industry k to which a firm belongs. If a firms

current period CFO is better (worse) than the median for industry k a firms current relative

performance is classified as good (poor). I denote the two groups formed following EI/CFOg

(current relative performance good) and EI/CFOp (current relative performance poor). Again,

industry is based on SGX classifications.

[Take in Table 7 About Here]

If AC-Pro member presence, heightened AC-External Auditor Familiarity and greater AC-

Directorate Interlock levels increase audit committee effectiveness in constraining earnings

management, coefficients on ACProf, ACAP Score and AC-Locks should be positive (negative)

28
for the EI/CFOg (EI/CFOp) sample. Table 7 Panels A and B findings show coefficients on

ACProf are positive (negative) and statistically significant at conventional levels for regressions

using the EI/CFOg (EI/CFOp) sample. The findings imply that, relative to firms without the

presence of at least one Pro-AC member, firms with at least one Pro-AC member are less

effective in constraining income-increasing (income-decreasing) accrual choices when corporate

management face income-increasing (income-decreasing) incentives. Coefficients on ACAP

Score, meanwhile, are negatively (positively) statistically significant at conventional levels for

regressions using the EI/CFOg (EI/CFOp) sample. Findings show heightened AC-External

Auditor Familiarity increases audit committee effectiveness in constraining income-increasing

(income-decreasing) accrual choices when corporate management faces income-increasing

(income-decreasing) incentives. Finally, coefficients on AC-Locks are positive (positive) in

regressions using the EI/CFOg (EI/CFOp) sample. Coefficients, however, are not statistically

significant at conventional levels. Thus, presence of an interlocked independent director does

not influence an audit committees ability to constrain earnings management regardless of

income-increasing or income-decreasing incentives. In conclusion, Table 7 findings provide

further supplementary empirical evidence to support inferences drawn from Table 5 results.

5.3 Alternative Proxies for Independent Variables

To further test robustness I construct alternative proxy measures for each independent variable. In

the case of ACProf I adjust the cut-off criteria to create two alternative proxies termed HACProf

and EHACProf. For HACProf the cut-off for the minimum number of boards of directors an

individual must sit on simultaneously is raised to seven and for EHACProf to nine.24 Again

dichotomous scaling is used to score firm-years. Regression tests based on Model I and Model IV

24
Conditions that (i) the individual serves solely as an independent director and (ii) serves on at least eighty
percent of the audit committee of the corporate boards to which individual is a member still applied.

29
are then repeated for each alternative proxy. Coefficients (not tabulated for brevity) on HACProf

and EHACProf are all significantly positively associated (p<0.05) with Abs(ACC). Explanatory

power of additional regressions is marginally stronger than Table 5 findings. Overall, findings

using the alternative proxy measures HACProf and EHACProf provide additional support of a

positive association between Pro-AC member presence and earnings management.

For AC-External Auditor Familiarity I create three alternative proxies denoted as ACA Score,

#ACAP Links and #ACA Links. To create ACA Score I score firms based only on whether the first

condition25 specified in the scoring criteria for ACAP Score is met. This scoring approach results

in a dichotomous scale with firm-years coded one if the prescribed condition is met, otherwise

zero. To score #ACAP Links I sum the total number of links (link is defined in accordance the

definition for AC-External Auditor Familiarity) for each firm. The sum total is scaled by the

total number of independent directors on the audit committee. For #ACA Links scoring follows

the same procedure as for #ACAP Links though the definition of a link is consistent with that

employed to score ACA Score. Findings of multiple regression tests (not tabulated for brevity)

based on Model II and Model IV using the three alternative proxies is generally comparable to

Table 5 results. Two differences of any relative note are: (a) coefficients on ACAP Score are

significant at p<0.10 rather than p<0. 05; and (b) coefficients on ACAP Links are significant at the

p<0.01 rather than p<0.05.

Finally, I create a single alternative proxy measure for AC-Locks. Specifically, I use a

dichotomous score whereby I code all firms having at least one interlocked independent director

on the audit committee one, otherwise zero. This alternative proxy is termed Dich: AC-Locks.

Regression analysis based on Model III and Model IV is then performed. Results (not tabulated

25
That is, at least one independent director on audit committee sits simultaneously on the audit committee
of another firm as an independent director and incumbent external auditor for both firms being identical.

30
for brevity) are consistent with Table 5 findings though the explanatory power of regressions

using Dich: AC-Locks is slightly lower.

5.4 Other Sensitivity Tests

As noted earlier, corporate governance data is based on contemporaneous information. As a

further test of robustness I repeat the multiple regression analysis using lagged corporate

governance data. I exclude 21 firm-years from the additional tests as lagged data could not be

satisfactorily determined.26 Multiple regression tests with lagged corporate governance data yield

similar results to Table 5. A notable difference is coefficients on ACProf are significant at the

p<0.10 rather than p<0.05. Findings imply a lack of annual anomalies influencing results.

6. Summary Remarks and Conclusions

The general undertone of this study is properties of independent audit committee members may

enhance or impair audit committee independence such that the committees ability to constrain

earnings management is affected. In this study, I focus on three properties: (a) presence of a Pro-

AC member; (b) level of AC-External Auditor Familiarity; and (c) presence of an interlocked

independent audit committee. Empirical analysis is based on a final useable sample of 465

Singapore publicly traded firm-year observations. I document evidence implying audit

committees with a Pro-AC member are less effective in constraining opportunistic earnings

management. Conversely, audit committees having a higher level of familiarity between

independent audit committee members and the external auditor were more effective in

26
Elimination of 21 firm-years does not significantly alter descriptive statistics of the dependent variable
and control factors as reported in Table 3. The percentage of firms with at least one Pro-AC member
declined slightly (33.11%) whilst the mean ACAP Score is lower at 0.54. Meanwhile, mean (median)
interlocked independent audit committee membership is 4.86 (6.34). At least one interlocked
independent director serves on 13.11% of the audit committees.

31
constraining corporate management from over-stating (under-stating) earnings through income-

increasing (income-decreasing) accrual choices. Finally, contrary to recent promulgations by

some corporate governance advocates and institutional bodies, the presence of an interlocked

independent director did not appear to influence an audit committees effectiveness in

constraining earnings management. Results are robust to a string of sensitivity tests including

alternative proxies for earnings management, independent variable and control factors.

Findings have implications for numerous parties including auditors, institutional investors,

regulators, present and future board members and corporate governance reformists. For example,

findings imply a potential regulatory trade-off in balancing the need for experience on the audit

committee against individuals holding numerous audit committee positions simultaneously.

Regulators, corporate governance reformists and scholars alike argue audit committee

effectiveness is likely to be enhanced if members have more extensive corporate governance and

financial accounting knowledge and expertise. Imposition of legislation requiring firm engage the

services of individuals with such qualities will naturally reduce the available human resource

pool. Given this constraint there will be increasing opportunities for qualified individuals to serve

simultaneously, virtually within a full-time capacity, on a number of boards of directors and audit

committees. I show, however, audit committees comprising at least one individual serving

simultaneously on a high number of boards of directors and audit committees were less effective

in constraining earnings management. In light of these findings, regulations stipulating audit

committees be comprised of individuals with specific skills may need to be tempered or have

greater voluntary flexibility. This implication is of particular concern to regulators in nations like

Singapore with a small natural population and a large number of publicly listed firms. Also,

results have empirical implications for scholars. Specifically, findings suggest researchers

examining the influence of audit committee independence may need to control for properties of

32
individual independent audit committee members (such as level of familiarity with the firms

external auditor) that can enhance or impair independence.

Despite some caveats, this study makes several unique contributions. I provide the first large-

scale empirical analysis of the association between earnings management and three audit

committee properties that may enhance/impair the committees independence. This advances

prior understanding of audit committee earnings management links beyond the examination of

audit committee composition with a standard fixation on the representational dichotomy between

insiders and outsiders. Also, the study helps to enrich the scope of future possible analysis of the

impact of audit committees on financial reporting processes. Further, unlike the majority of prior

earnings management corporate governance research I analyze data from Singapore a key

capital market within Asia. Analysis of Singapore data enriches the international understanding of

corporate governance earnings management links. Specifically, findings assist to determine if

recommendations to improve audit committee effectiveness that can assist in better constraining

earnings management can be universally applied. In addition, analysis of Singapore data allows

the opportunity to investigate in greater depth factors not as readily measurable using data from

Western economies. For instance, relative to available information in the United States and

Canada Singapore data I am able to include details related to the audit partner-in-charge. This

assists in the development of a more comprehensive proxy measure.

33
Table 1: Sample used in analysis and industry breakdown

Panel A: Sample formation


Firm-years
Description: 2000 2001
# Firms listed on SGX at start of year t 410 465
# Firms listing on SGX during year t-1 59 83
# Firms delisting from SGX during year t 13 25
# Foreign firms listed on SGX during year t 26 25
# Finance sector firms list on SGX during year t 29 24
# Firms with insufficient data to construct abnormal accruals in year t 18 14
# Firms from industry sectors without 8 observations in year t 53 20
# Firms with insufficient corporate governance data in year t 15 3
Outliers for absolute value of abnormal accruals 8 5
Final sample used 199 266
Panel B: Industry breakdown of final sample
Industry type 2000 2001
Commerce Retail 12 13
Commerce Wholesale 26 26
Construction 24 29
Finance - Banks Excluded Excluded
Finance Finance Companies Excluded Excluded
Finance - Insurance Excluded Excluded
Hotels and Restaurants 14 16
Information Technology Services Insuff. # 10
Manufacturing Chemical Products Insuff. # Insuff. #
Manufacturing Electrical Insuff. # 8
Manufacturing Electrical Products 21 25
Manufacturing Food and Beverage 10 12
Manufacturing Machinery and Equipment 9 11
Manufacturing Metal Products 12 15
Manufacturing Other Manufacturing 13 15
Manufacturing Petroleum Products Insuff. # Insuff. #
Manufacturing Printing and Publishing 10 12
Manufacturing Rubber and Plastic Insuff. # 9
Manufacturing Transport Equipment Insuff. # Insuff. #
Multi-Industry 18 20
Other - Healthcare Insuff. # Insuff. #
Postage and Telecommunications Insuff. # Insuff. #
Properties 19 21
General Services Insuff. # 10
Storage Insuff. # Insuff. #
Transport 11 14
Total: 199 266

34
Table 2: Variable descriptions, designation and predicted direction

Variable Description Variable Predicted


Designation Direction
Dependent Variable
Absolute value of abnormal accruals where abnormal accruals is
measured as the difference between total accruals and expected accruals ABS(AA) Not Applicable
calculated from the cross-sectional Jones model.
Independent Variable
Indicator variable with firms having a professional independent audit Indeterminable
committee member serving on the audit committee being scored a value ProfAC
of one (1); otherwise firms are scored a value of zero (0).
Total number of interlocks between independent directors on firmis Indeterminable
audit committee and firmis external auditor. An interlock is formed
ACAP Score
when an independent director sits on the audit committee of another
firm that is also client of the same external auditor firm for firmi.
Number of interlocked independent directors (defined as occurring Positive
when an executive director is a member of the board of directors of
AC-Locks
which the independent director is employed) serving on the audit
committee as percentage of total audit committee membership.
Control Factors
Number of individuals serving on the board of directors BoD Size Indeterminable
Percentage of the board of directors comprised of independent directors BoD Ind Negative
Indicator variable with firms having same individual occupying the roles Positive
of Chairperson and CEO jointly being scored a value of one (1); Duality
otherwise firms are scored a value of zero (0).
Percentage of outstanding common shares owned by executive directors Indeterminable
% Exe Dir Own
on the board of directors.
Ratio of total market of the firm at the beginning of the year to total Positive
MV/BV
book value of assets at the beginning of the year.
Absolute value of the change in a firms net income from year t-1 to Positive
ABSNI
year t.
Indicator variable with firms having two or more consecutive years of Indeterminable
negative income (ending on the fiscal year prior to the shareholders
Negative NI
meeting) being scored a value of one (1); otherwise firms are scored a
value of zero (0).
Ratio of a firms long-term debt at end of year t to total assets at the end Positive
Leverage
of year t-1.
Natural log of the book value of total assets. Firm Size Negative
Indicator variable with firms audited by a Big-Five audit firm being Negative
Auditor
scored a value of one (1); otherwise firms are scored a value of zero (0).
Percentage of outstanding common shares owned by top 20 shareholders Indeterminable
Owner Con
of the firm.
Change in operating cash flows for a firm between year t-1 and year t. CFO Negative

35
Table 3: Descriptive statistics
Panel A: Dependent variable and related components
Variable Mean Std. Dev Median Minimum Maximum % Positive
TAC -0.0697 0.1426 -0.0708 -0.5785 0.4241 30.23
ACC -0.0012 0.1106 0.0011 -1.5648 1.6808 55.53
Abs(ACC) 0.0657 0.0526 0.0524 0.0000 1.2745 100.00
Panel B: Basic board of director (BoD) and audit committee (AC) data
Features: Mean/Ptge Std. Dev Median Minimum Maximum
Board Size 7.10 1.77 7.00 4.00 13.00
# (%) Executive Directors on BoD 2.78 (40.13) 1.47 (18.59) 3.00 (40.00) 0.00 (0.00) 8.00 (80.00)
# (%) Non-Executive Directors on BoD 1.60 (20.90) 1.58 (18.78) 1.00 (16.67) 0.00 (0.00) 7.00 (75.00)
# (%) Independent Directors on BoD 2.71 (38.97) 1.14 (13.35) 2.00 (37.50) 1.00 (11.11) 9.00 (83.33)
Percentage of firms having BoD with:
100% Independent Directors 0.00 N/A N/A N/A N/A
Majority Independent Directors 14.16 N/A N/A N/A N/A
Duality - % of sample with 29.25 N/A N/A N/A N/A
Audit Committee Size 3.20 0.60 3.00 2.00 7.00
# (%) Executive Directors on AC 0.68 (21.10) 0.52 (16.48) 1.00 (33.33) 0.00 (0.00) 2.00 (40.00)
# (%) Non-Executive Directors on AC 0.20 (6.14) 0.45 (13.23) 0.00 (0.00) 0.00 (0.00) 3.00 (40.00)
# (%) Independent Directors on AC 2.32 (72.94) 0.58 (14.02) 2.00 (66.67) 2.00 (60.00) 4.00 (100.0)
Percentage of firms having AC with:
100% Independent Directors 18.24 N/A N/A N/A N/A
Majority Independent Directors 100.00 N/A N/A N/A N/A
Chairperson of BoD a Member 19.87 N/A N/A N/A N/A
CEO a Member 5.83 N/A N/A N/A N/A
Managing Director a Member 13.82 N/A N/A N/A N/A
Panel C: Independent variables and related components
Variable Mean/Ptge Std. Dev Median Minimum Maximum
ProfAC - % sample with 34.30 N/A N/A N/A N/A
ProfAC Positions Held 5.43 1.90 5.00 4.00 13.00
Independent Dir. On AC Positions 1.68 1.39 1.00 1.00 13.00
ACAP Score 0.58 0.67 0.00 0.00 2.00
Percentage Firms Scoring 2 10.32 N/A N/A N/A N/A
Percentage Firms Scoring 1 37.63 N/A N/A N/A N/A
Percentage Firms Scoring 0 52.04 N/A N/A N/A N/A
AC-Locks 4.57 10.91 6.10 0.00 50.00
Panel D: Control factors (BoD Size and BoD Ind values reported above)
Variable Mean/Ptge Std. Dev Median Minimum Maximum
MV/BV 1.419 2.938 0.900 -5.790 44.450
% Exe Dir Own 16.068 22.057 4.651 0.000 89.266
ABSNI (S$000) 15600.0 70108.0 3555.0 14.00 1072695
Negative NI (%) 17.49 N/A N/A N/A N/A
Leverage 0.098 0.128 0.048 0.000 0.897
Firm Size 18.819 1.322 18.658 15.423 23.609
Total Assets (SGD$000) 603,016.81 2,847,377.37 121,967.00 8,271.00 38,371,664.0
Auditor (%) 89.46 N/A N/A N/A N/A
Owner Con 77.08 14.19 79.30 0.00 100.00
CFO 0.061 0.205 0.060 -0.624 1.0195
Where: for continuous variables the value shown in the mean whilst for discrete variables the percentage of the sample
meeting the defined criteria is reported; total number of audit committee positions held by those designated as a Pro-AC
member by total number of Pro-AC members; mean audit committee positions held by independent directors on each firms
audit committee See Table 2 for formal descriptions of dependent and independent variables, and control factors that are all
shown in table in italics.

36
Table 4: Pearson correlation coefficient among dependent and independent variables, and control factors

Variables: 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Abs(ACC) 0.163 -0.187 0.071 -0.118 0.021 -0.002 0.022 0.058 -0.020 0.353 -0.104 -0.292 -0.140 -0.126 -0.156
ProfAC (1) 1.000 0.387 0.231 0.065 0.079 0.121 0.034 -0.084 -0.014 -0.012 0.082 0.194 0.052 0.102 0.022
ACAP Score (2) 1.000 0.312 0.138 0.097 0.033 0.007 0.075 -0.014 -0.134 -0.011 0.202 0.194 0.074 0.113
AC-Locks (3) 1.000 0.238 0.168 0.133 0.047 0.025 0.114 -0.134 -0.051 0.144 0.094 0.064 0.034
BoD Size (4) 1.000 -0.240 -0.161 -0.233 0.011 0.062 -0.182 0.043 0.479 0.094 0.061 0.108
BoD Ind (5) 1.000 -0.022 -0.076 0.101 0.021 0.086 -0.017 0.164 0.063 -0.026 0.158
Duality (6) 1.000 0.229 -0.070 -0.018 -0.022 0.073 -0.090 -0.026 0.039 -0.103
% Exe Dir Own (7) 1.000 -0.022 -0.012 -0.044 -0.021 -0.282 0.031 -0.012 -0.133
MV/BV (8) 1.000 0.026 -0.044 0.061 -0.016 0.073 0.090 0.162
ABS NI (9) 1.000 0.003 -0.019 0.071 0.011 0.074 0.134
Negative NI (10) 1.000 -0.021 -0.186 -0.137 -0.217 -0.137
Leverage (11) 1.000 0.233 0.033 -0.111 0.060
Size (12) 1.000 0.150 0.084 0.320
Auditor (13) 1.000 0.077 0.103
Owner Con (14) 1.000 0.124
CFO (15) 1.000
Where:
= Pearson correlation coefficient significant at the p 0.01, two-sided.
= Pearson correlation coefficient significant at the p 0.05, two-sided.
See Table 2 for formal definitions of the dependent variable, independent variables and control factors.

37
Table 5: Main multiple regression results

Abs(ACC)i = ai + i1ACProfi + i2 ACAP Score i + i3AC-Locksi + i4BoD Sizei - i5BoD Indi + i6Dualityi + i7% Exe Dir Owni + i8MV/BVi + i9ABSNIi + i10Negative NIi +
i11Leveragei - i12Sizei - i13Auditori + i14Owner Coni + i15CFOi + i
Panel A Model I Panel B Model II Panel C Model III Panel D Model IV
Variable Predicted Coefficient Coefficient Coefficient Coefficient
Direction (t-statistic) (t-statistic) (t-statistic) (t-statistic)
Intercept 0.302 (2.871) 0.305 (2.920) 0.215 (1.692) 0.292 (2.698)
ACProf ? 0.034 (2.571) Not Included Not Included 0.032 (2.173)
ACAP Score ? Not Included -0.036 (-3.024) Not Included -0.030 (-2.405)
AC-Locks + Not Included Not Included 0.023 (1.477) 0.020 (1.202)
BoD Size ? 0.008 (1.353) 0.009 (1.513) 0.007 (1.452) 0.009 (1.510)
BoD Ind - -0.001 (-0.921) -0.001 (-1.005) 0.000 (-0.782) -0.001 (-1.068)
Duality + 0.008 (0.414) 0.006 (0.328) 0.008 (0.500) 0.009 (0.475)
% Exe Dir Own ? 0.000 (-0.556) 0.000 (0.573) 0.000 (-1.235) 0.000 (-0.493)
MV/BV + 0.005 (1.630) 0.006 (2.040)** 0.000 (0.969) 0.005 (1.846)**
ABS NI + 0.000 (0.109) 0.000 (0.077) 0.000 (-0.082) 0.000 (0.044)
Negative NI ? 0.159 (3.113) 0.152 (2.813) 0.141 (3.209) 0.155 (2.919)
Leverage + -0.065 (-0.980) -0.084 (-1.273) -0.055 (-0.952) -0.077 (-1.159)
Size - -0.033 (-4.060)* -0.034 (-4.147)* -0.029 (-3.612)* -0.032 (3.949)*
Auditor - -0.059 (-2.213)** -0.069 (-2.560)* -0.055 (-2.009)** -0.068 (2.517)*
Owner Con ? -0.001 (-1.269) -0.001 (-1.453) -0.003 (-1.989) -0.001 (1.296)
CFO - -0.160 (-4.137)* -0.153 (-4.175)* -0.154 (-4.160)* -0.153 (-4.155)*
Model Summary Adjusted R2 = 0.203 Adjusted R2 = 0.211 Adjusted R2 = 0.195 Adjusted R2 = 0.214
F-Statistic = 8.422* F-Statistic = 8.649* F-Statistic = 7.615* F-Statistic = 8.194*
N = 465 N = 465 N = 465 N = 465
Durbin-Watson = 2.115 Durbin-Watson = 2.095 Durbin-Watson = 2.122 Durbin-Watson = 2.111
Where:
= coefficient significant at the p 0.01, two-sided if directional sign indeterminable;
= coefficient significant at the p 0.05, two-sided if directional sign indeterminable;
* = coefficient significant at the p 0.01, one-sided if directional sign indeterminable;
** = coefficient significant at the p 0.05, one-sided if directional sign indeterminable;
i = firm-year 1 through 465; = coefficient for variables 1 through 15; = model residual; and
See Table 2 for formal definitions of the dependent variable, independent variables and control factors.

38
Table 6: Abbreviated summary sensitivity tests with alternative earnings management proxy measures

Abs(ACC)i = ai + i1ACProfi + i2 ACAP Score i + i3AC-Locksi + i4BoD Sizei - i5BoD Indi +


i6Dualityi + i7% Exe Dir Owni + i8MV/BVi + i9ABSNIi + i10Negative NIi + i11Leveragei -
i12Sizei - i13Auditori + i14Owner Coni + i15CFOi + i
Panel A: Abs(ACC): total accruals - modified cross-sectional Jones (1991) model
Model I Model II Model III Model IV
Variable Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic)
ACProf 0.031 (2.317) Not Included Not Included 0.029 (2.002)
ACAP Score Not Included -0.034 (-2.686) Not Included -0.032 (-2.175)
AC-Locks Not Included Not Included 0.019 (1.153) 0.015 (0.925)
Model Adj. R2: 0.197 Adj. R2: 0.208 Adj. R2: 0.185 Adj. R2: 0.205
Summary: F-Stat.: 7.923* F-Stat.: 8.412* F-Stat.: 6.121* F-Stat.: 7.672*
Panel B: Abs(ACC): working capital accruals - original cross-sectional Jones (1991) model
Model I Model II Model III Model IV
Variable Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic)
ACProf 0.043 (1.781) Not Included Not Included 0.041 (1.725)
ACAP Score Not Included -0.054 (-2.732) Not Included -0.050 (-2.437)
AC-Locks Not Included Not Included 0.022 (0.821) 0.023 (0.882)
2 2 2
Model Adj. R : 0.102 Adj. R : 0.111 Adj. R : 0.089 Adj. R2: 0.108
Summary: F-Stat.: 4.231* F-Stat.: 4.790* F-Stat.: 3.883* F-Stat.: 4.161*
Panel C: Abs(ACC): working capital accruals modified cross-sectional Jones (1991) model
Model I Model II Model III Model IV
Variable Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic)
ACProf 0.040 (1.709) Not Included Not Included 0.039 (1.661)
ACAP Score Not Included -0.053 (-2.609) Not Included -0.052 (-2.534)
AC-Locks Not Included Not Included 0.025 (1.016) 0.018 (0.577)
Model Adj. R2: 0.098 Adj. R2: 0.109 Adj. R2: 0.090 Adj. R2: 0.106
Summary: F-Stat.: 4.144* F-Stat.: 4.583* F-Stat.: 3.975* F-Stat.: 4.024*
Where:
= coefficient significant at the p 0.01, two-sided if directional sign indeterminable;
= coefficient significant at the p 0.05, two-sided if directional sign indeterminable;
* = coefficient significant at the p 0.01, one-sided if directional sign indeterminable;
** = coefficient significant at the p 0.05, one-sided if directional sign indeterminable;
i = firm-year 1 through 465; = coefficient for variables 1 through 15; = model residual; and
See Table 2 for formal definitions of the dependent variable, independent variables and control factors.

39
Table 7: Abbreviated summary sensitivity tests after sample partitioning into EI/CFOg and EI/CFOp

ACCi = ai + i1ACProfi + i2 ACAP Score i + i3AC-Locksi + i4BoD Sizei - i5BoD Indi + i6Dualityi +
i7% Exe Dir Owni + i8MV/BVi + i9ABSNIi + i10Negative NIi + i11Leveragei - i12Sizei -
i13Auditori + i14Owner Coni + i15CFOi + i
Panel A: EI/CFOg sample with income-decreasinng incentives (CFO>0) (n=208)
Model I Model II Model III Model IV
Variable Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic)
ACProf 0.032 (2.023)** Not Included Not Included 0.027 (1.981)**
ACAP Score Not Included -0.036 (-2.671)* Not Included -0.030 (-2.246)**
AC-Locks Not Included Not Included 0.095 (1.137) 0.088 (1.061)
Model Adj. R2: 0.147 Adj. R2: 0.161 Adj. R2: 0.135 Adj. R2: 0.155
Summary: F-Stat.: 3.701* F-Stat.: 4.141* F-Stat.: 3.379* F-Stat.: 3.768*
Panel B: EI/CFOb sample with income-increasing incentives (CFO<0) (n=257)
Model I Model II Model III Model IV
Variable Coefficient Coefficient Coefficient Coefficient
(t-statistic) (t-statistic) (t-statistic) (t-statistic)
ACProf -0.025 (-1.811)** Not Included Not Included -0.021 (-1.737)**
ACAP Score Not Included 0.038 (3.003)* Not Included 0.034 (2.311)**
AC-Locks Not Included Not Included 0.089 (0.981) 0.085 (0.914)
2 2 2
Model Adj. R : 0.265 Adj. R : 0.274 Adj. R : 0.228 Adj. R2: 0.263
Summary: F-Stat.: 6.220* F-Stat.: 6.327* F-Stat.: 5.104* F-Stat.: 5.788*
Where:
* = coefficient significant at the p 0.01, one-sided;
** = coefficient significant at the p 0.05, one-sided;
i = firm-year 1 through 208 or 257; = coefficient for variables 1 through 15; = model residual; and
See Table 2 for formal definitions of the dependent variable, independent variables and control factors.

40
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Additional References from Text:
(Peasnell et al. 2000)
(Black et al. 1998)
(Bartov 1993)
(Bushee 1998)
(Bange and De Bondt 1998)
(McNicholas and Wilson 1988)
(Watts and Zimmerman 1986)
(Healy and Wahlen 1999; Weisbach 1988)
(Fama 1980)
(Klein 2002)
(Chtourou et al. 2001)
(Antle and Nalebuff 1991)
(Dye 1991)
(Jones 1991)
(Dechow et al. 1995)
(Kothari et al. 2001)
(Hair et al. 1995)
(Farrar and Glauber 1967)

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