Board monitoring and earning management; do outside director,s influence abnormal accrual,s?

Submitted to;
Sir Hammad Mirza

Submitted by;
Adeel umer 11-013 MBA (1.5) FINANCE

UNIVERSITY OF SARGODHA

Introduction
What is board monitoring?
We focus on two aspect of board monitoring 1. The role of outside board director,s Have a financial background Hold senior mgt position in other large corporation.

2.Audit commitee

What is earning management?

Manipulation of operating accrual,s is likekly to be a favored instrument for oppurtunistic earning management becaz they generally have no direct cash flow consequence and relativly difficult to detect A more costly method is to manipulate earning is by changing the way the firm does business. The firm could for example Boost reported profit by cutting back on advertising and research and development. There are many more possibilites. Selling asset it would otherwise keep.. Cutting back on staff development and essential equipment maintinance..

 The list is almost endless. All these actions are costly in the sense that they have negative affect on the firm,s future cash flow,s. Such manipultion reduce the value of the firm and as such are more costly then mere accounting manipulation. We therefore expect that the manipulation of accrual,s will be the instrument choosen frist, before mgt resort,s to more costly ones involving real changes in investment and operating activities.we focus on only accounting manipulations. We use abnormal accruals as our proxy for earning management.

Audit committee
audit committee has the specific responsibility for the production of financial statement and usually for communicating with the external auditor. Audit committee are not mandatory in the uk firms but listed companies are encouraged to form them.

Why focus on outside director,s

1. Outside directors contribute towards the integrity of financial statements. 2. Audit comitee has no direct impact on earning management. 3. Audit comitees are voulentry in uk. 4. Outside directors role is to resolve agency problem between managers and shareholders through the creation of appropriate employement contract.

Two reason for outside directors

1. Have a financial background 2. Hold senior management position in other large corporation

Data and sample

Our test are conducted using data for UK listed firms with fiscal year end,s between JUNE 30 1993 AND MAY31 1996. The number of firms 1993,94,95 were 620,651,657 respectfully. The maximum no of observation for any given industory-year combination is 56 while the mean estimation portfolio size is 21.. Board data were hand collected using the following sampling proceedureFor each year we selected the largest 1000 companies based on the market capitalization at december 31 as reported in the london share price database. We than excluded all financial firm,s becaz they have different accrual processes.we also excluded all regulated utilities becaz of diffrences in their incentive,s and oppurtunities to manage earning,s. THE PRICE WATERHOUSE CORPORATE REGISTER is used as the source of board composition data and firm,s annual report,s are used to identify the presence or absence of an audit comitee The final sample consist of 1271 firm year,s The final sample comprises of 559 firm,s The distribution of firm,s accros sample year is as follow.

 125 firm,s are included in only one year 156 firm,s are included in two year,s 278 firm,s are included in each of three year,s

Result,s
In US firm,s has low fraud cases where proportion of outside director,s is high Outside director,s contribute toward,s the integrity of financial statement Audit committee have no direct affect on earning management. We find that firm,s with higher proportion of outside board member,s are associated with less earning management.