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Does Industry Regulation Matter? New Evidence on Audit Committees and Earnings Management

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Abstract

This paper investigates the moderating role of industry regulation on the effectiveness of audit committees in restricting earnings management. Using comprehensive panel data of S&P 1500 firms between 2003 and 2007, we find that the proportion of CEO directors on an audit committee is positively associated with earnings management in unregulated industries, while this association is significantly weaker in regulated industries. Further, the proportion of financial experts on an audit committee is negatively associated with earnings management. Our results also indicate that the average board tenure of audit committee members is negatively related to earnings management in regulated industries, but positively affects earnings management in unregulated industries. Finally, audit committee members’ average directorship increases earnings management in regulated industries, but reduces earnings management in unregulated industries. Overall, our results suggest that the effectiveness of audit committees in reducing earnings management and improving financial reporting quality is influenced by industry regulation.

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Notes

  1. It should be noted that our aim is to examine the moderating role of an overall regulatory environment on the efficacy of audit committees instead of testing the effect of a specific regulation such as the SOX as in Ghosh et al. (2010) or a specific industry such as banking as in Palvia (2011) or airline as in Kole and Lehn (1999).

  2. The major difference between our main measure of earnings management, the performance adjusted discretionary current accrual method, and this alternative measure is that this alternative estimation does not control for firm performance. Please refer to Xie et al. (2003) for detailed explanation and calculation of this measure.

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Authors and Affiliations

  1. School of Business Administration and Economics, The College at Brockport, State University of New York, Brockport, NY, 14420, USA

    Lerong He

  2. E. Philip Saunders College of Business, Rochester Institute of Technology, Rochester, NY, USA

    Rong Yang

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  1. Lerong He
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  2. Rong Yang
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Correspondence to Lerong He.

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Table 7 Variable definitions
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He, L., Yang, R. Does Industry Regulation Matter? New Evidence on Audit Committees and Earnings Management. J Bus Ethics 123, 573–589 (2014). https://doi.org/10.1007/s10551-013-2011-9

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