The role of corporate governance mechanisms in constraining earnings management practice in Saudi Arabia

Abstract EN

Recent accounting literature and Agency theory predict that corporate governance assists the convergence of interests between shareholders and managers and thus, enhances the quality of financial reporting.

The primary objective of this paper is to empirically investigate the effect of the recent corporate governance regulations introduced by Capital Market Authority (CMA) on constraining earnings management practice in Saudi Arabia.

Earnings management is measured using the magnitude of discretionary ac-cruals as estimated by the performance matched discretionary accruals (Kothari et al., 2005) model.

A review of the corporate governance literature and regulations reveal six major attributes that can impact on shareholders’ perception of earnings quality due to their role in enhancing financial reporting integrity.

These attributes are tested using a unique hand-collected sample that con¬sists of all companies listed on the Saudi Stock Market.

The study covers the period of four financial years (2006, 2007, 2008, 2009).

Then hypotheses are tested using multivariate technique to determine if corporate governance at-tributes significantly constrain discretionary accruals.

The results reveal that some corporate governance attributes, namely board size and independence, are negatively associated with earnings management at significant levels.

The primary contribution to knowledge of this research is its extension of the literature on the role of corporate governance in constraining earnings management practice in Saudi Arabia.

This study’s results provide empirical evidence to assist regulators (CMA) in defining effective corporate gover¬nance attributes and assessing the disclosure of corporate governance prac¬tices and offer some suggestions to improve corporate governance system in Saudi Arabia.

The findings are also useable by stock market participants in their evaluation of corporate governance roles in enhancing earnings quality.