Board Independence and Real Earnings Management: The Case of R&D Expenditure

Abstract

Manuscript Type: EmpiricalResearch Question/Issue: This paper analyzes the role of boards of directors in constraining research and development (R&D) spending manipulation. Extant research on earnings management indicates that independent directors reduce accounting accruals manipulation; however, there is little evidence on their effectiveness in limiting potentially value reducing R&D cuts motivated by short-term earnings pressures. Research Findings/Results: Using a large sample of UK firms, I study whether independent boards are efficient at detecting and constraining myopic R&D cuts. The results indicate that more independent boards constrain the manipulation of R&D expenditure. The research design controls for the potential confounding effect of the decision to capitalize vs. expense R&D outlays. Theoretical Implications: The results indicate that independent directors have sufficient technical knowledge to identify opportunistic reductions in R&D, and efficiently constrain opportunistic R&D spending. Practical Implications: The evidence supports the emphasis that recent policy statements have put on increasing the number of independent directors on corporate boards. This study offers insights to policy makers interested in enhancing the monitoring role of corporate boards.

R D expenditures and earnings targets: evidence from France

“…Some studies focus on the reduction of investment in R&D in order to smoothen the results around the average analysts forecast (Graham et al, 2005;Perry and Grinaker, 1994;Bange and De Bondt, 1998;Mande et al, 2000). However, some authors document that R&D creates a serious timing problem because most of the annual R&D spent is likely to have occurred before analysts' forecasts (Osma, 2008;Osma and Young, 2009;Dumas, 2012). A number of studies provide evidence that managers intentionally decrease R&D investments to meet the first two thresholds mentioned by Degeorge et al (1999).…”

“…The variable of interest is the R&D cut variable which is assigned a value of one if R&D spending is lower than previous period spending and zero otherwise (Osma, 2008;Zhang and He, 2013;Xu and Yan, 2013;Tahikanis, 2014;He et al, 2015). To verify that earnings targets influence R&D investment by encouraging R&D cuts, the earnings targets are used as the independent variables.…”

The role of corporate governance in accounting discretion under IFRS: Goodwill impairment in Australia

“…The financial reporting outcomes examined include disclosure (Beekes and Brown, 2006;Cerbioni and Parbonetti, 2007;Kent and Stewart, 2008), conservatism (Ahmed and Duellman, 2007;Kim et al, 2003), manipulation of research and development expenditure (Osma, 2008), earnings management (Bedard et al, 2004;Nelson et al, 2003;Peasnell et al, 2005;Xie et al, 2003), and fraud and financial restatements (Abbott et al, 2004;Sharma, 2004 (2001) finds that audit committees appear to be more effective in reducing the size of restructuring and other discretionary charges when the audit committee has at least one member who has accounting or related financial expertise. Nelson et al (2003) report results suggesting that auditors are less likely to waive earnings management attempts that increase current-year income, and more likely to waive attempts they view as immaterial.…”

The Influence of Corporate Governance in Chinese Companies on Discretionary Accruals and Real Earnings Management

“…Mak and Kusnadi (2005) use the data of listed companies of Singapore and Malaysia to examine the effect of corporate governance on firm value, and find that the board size of these two countries has inverse relationship with firm value. Osma (2008) analyzes the relation between independent directors and real earnings management using the U.K public limited companies data, and demonstrates that higher percentage of independent directors can more restrain real earnings management of reducing the R & D expenditures. Nevertheless, Boone et al (2007) use a panel data model to trace corporate board development through 10 years after IPO, finding that board size and independence increase along with the growth of companies, and board size can cause the increase of benefits to monitoring and reduce the cost of such monitoring.…”

“…It includes studies, for instance, Fan and Wong (2002), Jung and Kwon (2002), Siregar and Utama (2008), Givoly et al (2009) and Xu et al (2012). Another line of research examines the relation between board characteristics and earnings equality, such as Vafeas (2000), Klein (2002), Park and Shin (2004), Osma (2008) and Dimitropoulos and Asteriou (2010). For the researches regarding to ownership structure, Tirole (2001) conducts the theoretical and empirical studies and argues that the different ownership structures may imply the different monitoring incentives.…”