Corporate Governance and Accounting Conservatism: Evidence from the Banking Industry

Abstract

Manuscript Type Empirical Research Question/Issue In this paper, we empirically investigate whether US listed commercial banks with effective corporate governance structures engage in higher levels of conservative financial accounting and reporting. Research Findings/Insights Using both market‐ and accrual‐based measures of conservatism and both composite and disaggregated governance indices, we document convincing evidence that well‐governed banks engage in significantly higher levels of conditional conservatism in their financial reporting practices. For example, we find that banks with effective governance structures, particularly those with effective board and audit governance structures, recognize loan loss provisions that are larger relative to changes in nonperforming loans compared to their counterparts with ineffective governance structures. Theoretical/Academic Implications We contribute to the extant literature on the relationship between corporate governance and quality of accounting information by providing evidence that banks with effective governance structures practice higher levels of accounting conservatism. Practitioner/Policy Implications The findings of this study would be useful to US bank regulators/supervisors in improving the existing regulatory framework by focusing on accounting conservatism as a complement to corporate governance in mitigating the opaqueness and intense information asymmetry that plague banks.

Advancing the Corporate Governance Research Agenda

“…In particular, the "specialness" of banks, as analytically discussed by John et al (2016), Zalewska (2016), and Srivastav and Hagendorff (2016) in this special issue, requires an analytical framework that does not focus exclusively on protecting the interests of equity claimants but also expands to incorporating non-shareholder constituencies' interests such as depositors and the society-at-large. In the presence of potentially conflicting interests among heterogeneous constituents, the effectiveness of traditional governance mechanisms is also limited for the case of banks (see Grove, Patelli, Victoravich, & Xu, 2011;Leventis, Dimitropoulos, & Owusu-Ansah, 2013). More research is therefore warranted on the corporate governance of banks and, more specifically, on determining what constitutes good governance for financial entities.…”

An Analysis of the Earnings Quality of Iranian Public and Private Firms

“…Leventis et al . (2013) showed that managers and policy‐makers of a business must focus on corporate governance in order to improve information quality. For instance, Firth et al .…”

Board Committees in Corporate Governance: A Cross‐Disciplinary Review and Agenda for the Future

“…For example, financial reporting quality, measured as fewer restatements and discretionary accruals, was improved by the audit committee having greater legal and accounting expertise (Krishnan et al, 2011), as well as a greater number of accounting and industry experts (Cohen et al, 2013). Similarly, fully independent and active audit committees were associated with a reduced likelihood of restatements and larger recognition of loan loss provisions (Abbott et al, 2004;Leventis et al, 2013). Indeed, in pre-IPO firms the mere presence of an audit committee can reduce accruals (Venkataraman et al, 2008).…”