Board of director's diversity and earnings management: the moderating effect of the board's roles

Purpose – This study aims to explore the influence of Board diversity on earnings management in two aspects: accruals earnings management (AEM) and real earnings management (REM). The study also examines the Board of director's roles – monitoring and advisory functions – as a moderator on the link between Board diversity and earnings management.
Design/methodology/approach – This paper uses fixed-effect regression analysis of a sample of 13522 firm-year observations in six developed countries around the world: Australia, Singapore, Hong Kong, Canada, the UK, and the US, from 2016-2020. In this study, absolute values of abnormal discretionary accruals are employed as a proxy for AEM in the cross-sectional modified version of Jones (1991) and Dechow & Dichev (2002). We also employ Roychowdhury (2006) 's empirical models as a proxy for REM, representing the manipulation of real activities.
Findings – The findings indicate that Board diversity has a negative relationship with AEM, but a positive relationship with REM. In this regard, there is evidence that sample companies may switch between earnings management strategies, shifting from AEM to REM and employing them as substitutes. Additionally, the research confirms that Board monitoring and advisory roles can reduce earnings management. However, the negative link between Board diversity and AEM is less pronounced when two Board roles are stronger. The findings imply that 'the substitutive role', which balances Board diversity and Board roles in these effects, has more influence on AEM. In contrast, dual Board roles enhance the link between Board diversity and REM, but this relationship is not statistically significant. The results suggest that Board roles play a complementary function in improving earnings quality as measured by REM.
Originality/value - The authors add to the body of knowledge on accounting quality and corporate governance by pointing out how Board diversity is linked to better earnings quality and lower earnings management in publicly listed companies worldwide. Moreover, this paper adds to prior literature about the Board of directors and accounting quality by identifying additional substitutive and complementary aspects of the Board of directors' roles. In doing so, this study applies the multi-theoretical perspectives – human capital theory, agency theory, and resource dependence theory – to examine these effects.