Board Monitoring and Earnings Management: Do Outside Directors Influence Abnormal Accruals?

Abstract: This paper examines whether the incidence of earnings management by UK firms depends on board monitoring. We focus on two aspects of board monitoring: the role of outside board members and the audit committee. Results indicate that the likelihood of managers making income‐increasing abnormal accruals to avoid reporting losses and earnings reductions is negatively related to the proportion of outsiders on the board. We also find that the chance of abnormal accruals being large enough to turn a loss into a profit or to ensure that profit does not decline is significantly lower for firms with a high proportion of outside board members. In contrast, we find little evidence that outside directors…