Disclosure Quality, Corporate Governance and Earnings Management

Abstract

This study investigates the association between the proxies of disclosure quality and earnings management in the UK listed companies. Building on extant literature, it contributes to providing new insights on simultaneous relationship between disclosure quality and earnings management while controlling for internal governance mechanisms. Unlike prior studies, this study also examines the potential substitutive or complementary effects of disclosure quality and internal governance in explaining earnings management. The evidence suggests an inverse bi-directional relationship between disclosure quality and earnings management, implying that the higher the disclosure quality, the lower the earnings management and vice-versa. Moreover, the outperformance of disclosure quality over internal governance mechanisms in curbing earnings management is documented indicating substituting effects between disclosure quality and corporate governance mechanisms. These findings are consistent with the premise that in the presence of high quality disclosure regime, investors are well/better informed about all material activities of the companies that provide managers less incentive to manipulate earnings at the costs of investors. These results suggest strengthening of internal governance mechanisms to protect investors from potential earnings management as well as upholding the disclosure quality in firms' settings.