The effectiveness of internal corporate governance mechanisms and ownership structure in constraining earnings management in Jordan

Abstract

The root of conflict of interest problem arises as a response to the separation between management and ownership in firms, in which firm’s agents are motivated to adopt specific actions to maximise their personal wealth at the expense of shareholders. Therefore, various initiatives made by interested groups introduced corporate governance (CG) codes and ownership structure as deterrent monitoring tools to constrain earnings management (EM) behaviours. Motivated by a functionalist research paradigm, this thesis aims to evaluate the current effects of some of the key mechanisms of CG and ownership types in constraining EM decisions over firm’s accruals in Jordan.

Taking advantage of the functionalist research paradigm, this thesis adopts a mixed-methodology approach in which a subjectivism and objectivism research positions are used to evaluate the effectiveness of the monitoring mechanisms in constraining EM techniques. Under the objectivist stand, a set of secondary data from 2009 to 2014 explores the relationships between internal CG mechanisms and ownership structure and EM phenomenon estimated by the Modified Jones (1995) model over a sample of 134 non-financial firms listed in Amman Stock Exchange (ASE). In this strand, independent members, external directorships, board size, board meetings and non-duality managers were the main mechanisms selected to evaluate board-monitoring functions. Additionally, this thesis captures the monitoring effects of audit committees (AC) through three main characteristics (AC existence, AC independence and AC meetings). Finally, with regard to ownership structure, this part covers institutional owners, blockholder owners, managerial owners and family firms.

After testing for normality, linearity, multicollinearity and heteroscedasticity and time-fixed effects, the regression results show a significant monitoring tendency for independent board members in constraining EM issue. However, as the number of external directorships occupied by board members increased, the likelihood of engaging in EM decisions increased significantly. Additionally, active boards (meetings) showed a deterrent monitoring position in reducing the passage of opportunistic behaviours over firm’s accruals.

The regression analysis provided evidence that supports institutional theory regarding the existence of a separate AC. Indeed, the main finding claims that Jordanian directors have been responding to the Jordanian Securities Commission pressures in terms of establishing a separate AC in their firms since a positive correlation between EM levels and the presence of AC is documented. Statistically speaking, this thesis found evidence that independent members were inclined significantly to enhance financial reports quality by reducing the prevalence of EM behaviours in Jordan.

Supporting the researcher hypotheses that assumed a significant monitoring role of the concentrated ownership in constraining managers’ opportunistic behaviours, only blockholder with at least 5% of firm’s outstanding shares were significantly effective in controlling managers’ opportunistic behaviours estimated by discretionary accruals. However, and in line with the researcher expectations, family firms were a fertile environment for earnings management.

With regard to the subjectivist approach, this thesis adopted other complementary approaches such as questionnaire and face-to-face interviews to achieve the research goals. Indeed, these approaches seek mainly to explore participants’ perceptions to evaluate the controlling functions of the monitoring tools, and further, to shed light on the main techniques used to alter firm’s earnings via accruals decisions.

However, with a valid response rate (42.8%) extracted from 320 distributed questionnaires from various respondents (i.e. board members, AC members, external auditors and governmental employees), the participants noted the following techniques as the main choices to alter firm’s earnings in Jordan; “altering depreciation policy”, “altering account receivable policy” and “altering inventory amounts". In terms of the monitoring tools, in general, the participants suggested ownership mechanisms as a deterrent tool to constrain EM in comparison with CG mechanisms, in which the recorded perceptions revealed weak monitoring effects on EM decisions.

To provide further insights to achieve the research objectives, the researcher interviewed twelve participants selected during the process of administering the questionnaires. The interviewees indicated favouritism, tribalism and Arab spring as the main obstacles that hindered the CG mechanisms from being deterrent tools to activate the monitoring roles of these mechanisms. In addition, independence issue for both board and AC members is still mere ink on paper since the previous obstacles played a significant role in restricting this issue in Jordan.

It is worth mentioning that, adopting a functionalist research position to achieve the thesis goals through a mixed-methodology approach has helped the researcher to widen the adopted theoretical framework in this thesis, to go beyond the adoption of one theory (agency theory) by considering the effects of the institutional theory, resource dependency theory and stewardship theory.

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Identifiers

ORCID for Oliver Marnet: orcid.org/0000-0001-9450-2332

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