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Do staggered boards affect financial reporting quality?

Yijiang Zhao, University of Nebraska - Lincoln

Abstract

The recent wave of corporate fraud and scandals has raised concerns on the practices of protecting directors from the threat of removal. This study examines the association between protecting directors from removal and financial reporting quality. ^ Existing theories suggest two opposite effects on financial reporting quality when directors are protected from removal. Entrenchment theory argues that measures to protect directors from removal increase both managers' motivations and opportunities to manipulate earnings, asserting a negative association between protection from removal and financial reporting quality. In contrast, alignment theory predicts a positive association between protecting directors from removal and financial reporting quality. ^ This study uses the existence of staggered boards as a proxy for directors' protection from removal. By adopting three widely used measures of financial reporting quality (i.e., the occurrence of financial reporting fraud, the likelihood of financial statement misstatements, and earnings management), this study attempts to provide a complete picture of how protecting directors from removal affects financial reporting quality. ^ First, selecting fraud cases between 1995 and 2001 from the SEC's Accounting and Auditing Enforcement Releases and using a matched-pair methodology, this study shows that fraud firms are less likely to have staggered boards that protect directors from removal. Next, selecting firms that misstated financial statements during 1995-2001 and using a matched-pair methodology, this study shows that firms without staggered boards are more likely to inflate reported earnings. Finally, focusing on the constituents in the S&P 1,500 for the period 1995-2001, this study shows that staggered boards are associated with lower levels of earnings management. The above results remain unchanged in various robustness tests. ^ Overall, the findings favor the alignment theory, which states that protecting directors from removal helps improve financial reporting quality. The findings can help resolve the debates on the merit of protecting directors from removal, point a way to improve financial reporting quality, and shed additional insights into the associations between corporate governance and financial reporting quality. ^

Subject Area

Business Administration, Accounting

Recommended Citation

Zhao, Yijiang, "Do staggered boards affect financial reporting quality?" (2005). ETD collection for University of Nebraska - Lincoln. AAI3199707.
http://digitalcommons.unl.edu/dissertations/AAI3199707

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