Relationship of Corporate Governance and Earning Quality – Special Study in India

Abstract

Corporate governance has become a key factor determining a company’s transparency, accountability and financial reporting quality. As corporate restructuring, investor activism and financial sector reforms are becoming increasingly apparent in emerging economies like India after the country’s liberalization, the influence of corporate governance on earning quality of listed companies has become an area of interest for researchers and practitioners alike. This study attempts to correlate the governance quality of a company and its earnings quality using a comprehensive governance score and established earnings quality score.

This study includes an analysis of 389 listed, non-financial companies from BSE 500 Index for financial year 2023–24. However, all banking and financial service companies are excluded as conventional measures of earnings quality will not apply to highly regulated financial institutions. A composite score of corporate governance of sample firms was created by using seven indicators like 1. Size of the board; 2. Independence of Board; 3. Proportion of female directors on board; 4. Board Meeting frequency; 5. Independence of audit committee; 6 CEO - Chairman Duality; and 7. Quality of audit reports.

In terms of earnings quality, the study uses Beneish M-Score, a widely used indicator that computes a score that identifies probability of earnings manipulation. The empirical results from an ordinal regression model estimated using the sample data indicate that the corporate governance has a statistically significant impact on the earning quality of a firm.

To test the above stated hypothesis an ordinal regression has been used. Control variables like Size of firm, ROA, EPS, PAT, Institutional holdings and Industry of firm has been used in the study to make it more robust. All statistical computation has been done by IBM SPSS software.

The findings of this study highlighted positive association between Corporate Governance practices followed by firm and its earnings quality. In short higher quality of corporate governance practices results into better earnings quality by reducing possibility of earnings manipulation and ensuring reliability of reported earnings.

The findings of this study must be useful to a number of different stakeholders including investors, managers, regulators and, most importantly, researchers who want to continue further research on this area.

This study has limitation of having data for single year i.e. FY2023-24 for sample of listed Indian companies only. Thus, future studies can rely on larger time series and even cross-country study..