Consequently, one of the most important functions of corporate governance is to ensure the quality of financial reporting. In 2009, a revised form of Iranian Code of Corporate Governance was issued and some governance requirements were added to the listing requirements of the Tehran Stock Exchange (TSE). This paper examines the effect of corporate governance on the quality of the financial reporting process by linking corporate governance characteristics to the quality of accounting earnings.
The relationship between corporate governance and earnings quality in different environments has not yet been clarified. The Iranian Corporate Governance and the motivation for conducting this study in Iran are presented in Section 3. In early 2000, a modern view of the corporate governance issue was addressed for the first time (Mashayekhi & Mashayekh, 2008).
In 2005, Iran improved its corporate governance procedures through the Iranian Code of Corporate Governance and the revised Securities Market Law. Based on the above discussions, we expect that the Iranian Code of Corporate Governance will improve the quality of financial reporting and thus earnings quality. One crucial element of corporate governance that has undergone reforms is the structure of the board of directors.
Research design
Vafeas (1999) finds that as the number of board meetings increases, companies' operating results improve. It is expected that an increase in the number of board meetings will provide more effective monitoring and likely improve financial reporting and earnings quality in Iranian companies. The concept of "earnings quality" developed in the context of increasing evidence of earnings management documented by researchers.
Consistent with the focus on decision utility adopted by the FASB and academic researchers, earnings quality and, more generally, financial reporting quality are of interest to those who use financial reports for contracting and investment decision-making purposes. Schipper and Vincent (2003) consider earnings quality constructs derived from the properties of earnings time series; qualitative characteristics selected in the FASB Conceptual Framework; the relationship between income, cash and accruals; and implementation decisions. Among these constructs, one commonly used construct in financial accounting research to examine earnings quality is related to time series properties of earnings (e.g. Sloan, 1996).
150 Total number of companies in the sample used in the main analysis. 600 Number of firm-year observations used in the main analysis. In this paper, we use earnings persistence, earnings predictability, and accrual quality proxies to measure earnings quality. Kormendi and Lipe (1987) develop a measure of earnings persistence where current year earnings are regressed on prior year earnings, both scaled by total assets at the beginning of the year.
Following Lipe (1990), Francis, LaFond, Olsson, and Schipper (2004) measure earnings predictability using the square root of the estimated error variance from the earnings persistence model. Therefore, the higher values of AQ and PRED and the lower values of PERS indicate poor earnings quality. We consider these variables because previous literature has found them to be related to the degree of earnings management and earnings quality.
Thus, we expect the coefficient of SIZE to be negative for PERS and positive for PRED and AQ, implying low earnings quality or more earnings management as firm size increases. Therefore, we expect the coefficient of LEV to be negative for PERS and positive for PRED and AQ, indicating low earnings quality or high earnings management as LEV increases. Thus, we expect MTB's coefficient to be negative for PERS and positive for PRED and AQ, indicating low earnings quality.
PRED = the square root of the estimated error variance of firm i in year t in Model 1 as earnings predictability;.
Empirical results
PRED is the square root of firm i's estimated error variance in year t in Model 1 as earnings predictability; DUAL is an indicator of whether or not a company's CEO is also chairman of the board of directors (DUAL equals 1 if the CEO is also chairman of the board of directors and 0 otherwise); SIZE is the size of the firm as measured by a natural logarithmic function of the firm's total assets;
LEV is total liabilities divided by total assets; and MTB is the fixed growth calculated as the market value of the equity over its book value. PRED is the square root of the estimated error variance for firm i in year t in model 1 as earnings predictability;. BMEET is the number of board meetings; SIZE is the company's size measured by a natural logarithmic function of the company's total assets; LEV is total liabilities divided by total assets; and MTB is the fixed growth calculated as the market value of the equity over its book value.
In this section, we conduct a multivariate analysis to check the effects of some of these factors when examining the influence of corporate governance on earnings quality. These variables explain approximately 58 percent, 47 percent, and 22 percent of the cross-sectional variation in PERS, PRED, and AQ, respectively. However, this contradicts Dallas (2003), who argues that larger board size provides firms with more resources and will therefore increase firm value.
These results suggest that the expectation of the agency theory about a positive relationship between external (independent) directors and financial reporting quality, and therefore earnings quality, also applies in Iran's business environment. Contrary to H3, which predicts that separate individuals for the position of CEO and the chairman of the board lead to a better corporate governance system and increased earnings quality, the presence of duality in Iranian firms does not have a. The frequency of board meetings (BMEET) has a significant positive correlation with the firm's earnings quality (t PERS, BMEET=2.235, t PRED, BMEET =-1.900).
Similar to the indications of Lin and Hwang (2010), these results suggest that the number of board meetings is increasing and that the number of board meetings is increasing. 2) PERS is the value of the estimated λ1 in Model 1 as earnings persistence; PRED is the square root of firm i's estimated error variance in year t in Model 1 as income predictability; AQ is the standard deviation of firm i's estimated residuals in Model 3 as the quality of accruals; BSIZE is the number of directors on the board; BOUT is the share of independent directors on the board of directors; DUAL is an indicator of whether a company's CEO is also chairman of the board of directors (DUAL equals 1 if the CEO is also chairman of the board of directors and 0 otherwise); BMEET is the number of board meetings; SIZE is the size of the firm as measured by a natural logarithmic function of the firm's total assets; LEV is total liabilities divided by total assets; and MTB is fixed growth calculated as the market value of equity over its book value. According to Models 4 and 5, the firm's leverage ratio has a statistically significant (but contradictory) effect on earnings quality (t PERS, LEV=-2.519, t PRED, LEV =2.139).
Note: PERS are the values of estimated λ1 in Model 1 as earnings persistence; PRED is the square root of the estimated error variance of firm i in year t in Model 1 as earnings predictability; AQ is the standard deviation of firm i's estimated residuals in Model 3 as accrual quality; SIZE is the size of the firm as measured by a natural logarithmic function of the firm's total assets; LEV is the total liabilities divided by total assets; and MTB is the fixed growth calculated as market value of equity over its book value.
Implications and conclusion
In fact, the presence of duality in Iranian companies did not have a significant negative impact on earnings quality. Board meeting frequency is significantly positively related to firm earnings quality, as measured by earnings persistence and earnings predictability. These results suggest that increasing the number of board meetings, which may lead to more effective discussion among directors on the board, will improve the quality of financial reporting and thus the quality of earnings in the Iranian capital market.
However, the evidence does not show a significant relationship between the number of board meetings and the quality of earnings as measured by the quality of accruals. In summary, the findings of this study show that there is no significant relationship between corporate governance and accrual quality for Iranian firms; however, corporate governance can affect earnings persistence and earnings predictability. This study provides some useful evidence, consistent with the initiatives of Iranian regulators, that stronger corporate governance mechanisms can be important factors in promoting the integrity of financial reporting of Iranian companies.
The result of this study can also help Iranian policy makers and companies' stakeholders to further improve corporate governance along with current transfer of companies. Similar to most previous work, the focus of this study is limited to only four (4) corporate governance measurements. It would be beneficial to include additional corporate governance variables such as institutional investors, compensation mix, audit committee and market control variables in future studies.
Future researchers can focus on the question of whether good corporate governance leads to better earnings quality or whether firms with higher quality earnings have better corporate governance. Findings from this study warrant further investigations into the role that the Iranian government's ownership structure plays in determining earnings quality in Iran. An empirical analysis of the relationship between board composition and financial statement fraud.
Report and Recommendations of the Blue Ribbon Committee on Improving the Effectiveness of Corporate Audit Committees. A cross-sectional analysis of the impact of corporate governance on the East Asian financial crisis.
