Does corporate governance influence earnings management in listed companies in Bahrain Bourse?
| DOI | https://doi.org/10.1108/JABS-06-2017-0082 |
| Published date | 10 December 2018 |
| Date | 10 December 2018 |
| Pages | 551-570 |
| Author | Bahaaeddin Alareeni |
| Subject Matter | Strategy,International business |
Does corporate governance influence
earnings management in listed companies
in Bahrain Bourse?
Bahaaeddin Alareeni
Abstract
Purpose –This paperaims to consider data for listed companies in BahrainBourse to determine whether
companies practice earnings management (EM). Further, the effect of a set of corporate governance
characteristicson EM practices is examined.
Design/methodology/approach –The EM level was measured using discretionary accruals (DA)
[calculated usingthe Modified Jones (1995) Model]. Thestudy sample consisted of 20 companies listed
during the period2011-2015. Panel regression model was used to test the studyhypotheses and achieve
the studyaims.
Findings –EM is negatively correlatedwith board size, confirming that a larger boardis associated with
a lower level of EM practices. Further,board independence is positively correlated withEM, suggesting
that the larger the number of independent directors, the higher the level of EM practices. In addition,
internal ownership is positively related to EM, confirming that the higher level of internal ownership
increases EM practices.CEO duality does not appear to have any effect on EM in Bahrain Bourse. More
interestingly,the findings reveal that companiespractice EM through income-increasing DA.
Research limitations/implications –Financial data and data related to other corporate governance
characteristicsare lacking.
Practical implications –The results of this study provideempirical support for the development of new
regulations and amendments and necessary corrective decisions regarding the effectiveness of
applying corporate governance code in Bahrain Bourse. More specifically, this study reveals an urgent
need for new amendmentsto restrict EM practices in Bahrain Bourse.
Originality/value –This study enrichesthe EM literature by covering Bahrain as an Asian country, which
has not been sufficiently examinedin relation to this topic. Further, this study provides a clear pictureof
the levelof EM practices in Bahrain Bourse to multiple parties.
Keywords Discretionary accruals, Board size, Corporate governance, CEO duality, Internal ownership,
Modified Jones (1995) model
Paper type Research paper
1. Introduction
Over the past few decades, there have been a number of well-known scandals in which
auditors failed to warn about the manipulation of firms’ financial reports (e.g.WorldCom and
Enron). Goncharov (2005) found that earnings management (EM) practices are typically at
the core of such scandals. Managers use some of the flexibility allowed by accounting
policies and practices to affect accounting profits (Parfet, 2000). Thus, fraud cases in the
stock markets have proven the existence of unethical behavior and revealed a need for
transparency and reliability in firms’ financial reports (Lang and Lundholm, 2000;Kardan,
et al.,2016
). High-profile corporate failures have also heightened global awareness of the
importance of corporate transparency, reliability and accountability (Ahmad-Zaluki and
Nordin Wan-Hussin, 2010;Shehata,2015).
Bahaaeddin Alareeni is
based at University of
Bahrain, Manama, Bahrain.
Received 3 June 2017
Revised 28 August 2017
16 November 2017
Accepted 22 December 2017
DOI 10.1108/JABS-06-2017-0082 VOL. 12 NO. 4 2018, pp. 551-570, ©Emerald Publishing Limited, ISSN 1558-7894 jJOURNAL OF ASIA BUSINESS STUDIES jPAGE 551
Because corporate failures have become a major concern for investors worldwide (Alareeni
and Branson, 2012;Dalwai et al.,2015), regulators have established corporate governance
to maintain investor interests, improve confidence in stock markets, protect information
transparency, mitigate conflicts of interest and increase auditor independence (Leuz et al.,
2003). A high governance level may prevent EM practicesamong managers (Gonza
´lez and
Garcı
´a-Meca, 2014), which could decrease the magnitude of company failures/
bankruptcies and thus positively affect shareholders and other related parties (Johnson
et al., 2000;Fich and Shivadasani, 2006;Cheng et al.,2010;Gonza
´lez and Garcı
´a-Meca,
2014).
Many prior studies have investigated the relationship between corporate governance
characteristics and EM practices (Brick et al., 2006;Hashim and Devi, 2008;Kumari and
Pattanayak, 2014;Campa and Donnelly, 2014). These studies have primarily been
conducted in developed countries and some developing countries in which investors and
all financial statement users are, in general, well-protected by the legal system and the level
of transparency is high. These studies have shown progress in the quality of earnings due
to the implementation of corporategovernance.
While the relationship between corporate governance characteristics and EM has been
tested extensively in developed countries, much less is known about this relationship in
developing countries, particularly Gulf Cooperation Council (GCC) countries as Asian
countries. More interestingly, the results on this relationship in developing countries differ
between studies depending on several factors such as industry, sample size, year of data
and economic environment.
For instance, in India and China, Sarkar et al. (2008) and Gulzar and Zongjun (2011) found
a significant positive association between CEO duality and EM, namely, boards that have
directors with multiple functions exhibit higher EM. By contrast, the findings of Castan
˜eda
(2000) did not support a positive impact of CEO duality on EM and showed that majority
owners occupy dual roles in 85 per cent of Mexican listed firms. In Malaysia, Saleh et al.
(2005) predicted a negative relationship between board size and EM, indicating that larger
boards are more likely to decrease the EM level. In the following year, Abdul Rahman and
Ali (2006) revealed that EM is positively related to boardsize in Malaysia, with no significant
relationship between other corporate governance characteristics and EM. In China, Liu and
Lu (2007) proved empirically that firms with higher levels of corporate governance have
lower levels of EM. Ali Shah et al. (2009) found that the relationship between corporate
governance and EM is positive for Pakistani listed firms. Finally, Al-Abbas (2009) found no
evidence of a relationship betweencorporate governance and EM in Saudi Arabia.
Recently, GCC countries have developed their own corporate governance codes. In this
regard, Shehata (2015) compared GCC corporate governance codes to clarify areas of
similarities and differences in the scopes and requirements of each code. He found major
differences in corporate social responsibility. In addition, corporate governance codes are
more recent in the Middle East and North Africa (MENA) region than in developed
countries. Considerable progress is needed in the MENA region, including the GCC and
other Asian countries, to reach the current status of corporate governance in developed
countries.
Thus, there is a real need to test the relationship between corporate governance and EM in
different economic environments using recent time periods and industries and, more
specifically, in the context of GCC countries as Asian countries in which the relationship
between corporate governanceand EM has received inadequate attention.
As an example GCC country, the situation in Bahrain remains questionable. Bahrain has
recently begun experiencing economic difficulties as a result of increasing oil prices. High
oil prices influence the costs of other production and manufacturing and increase transport
and other business costs. Ultimately, the high price of oil could affect the whole economy
PAGE 552 jJOURNAL OF ASIA BUSINESS STUDIES jVOL. 12 NO. 4 2018
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