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MAJ
27,1
66
Received 4 November 2010
Revised 29 April 2011
Accepted 19 May 2011
Managerial Auditing Journal
Vol. 27 No. 1, 2012
pp. 66-86
q Emerald Group Publishing Limited
0268-6902
DOI 10.1108/02686901211186108
Earnings management
and board oversight:
an international comparison
Habib Jouber and Hamadi Fakhfakh
Faculty of Economic Sciences and Management,
University of Sfax, Sfax, Tunisia
Abstract
Purpose This paper attempts to investigate the relationships between the board of directors
characteristics and earnings management being a proxy of earnings quality in two separate countries,
France and Canada. Specifically, it aims to investigate how certain contextual features affect
differently earnings management behavior, and to reveal which factors are the most prominent
incentives of management discretion in both cases.
Design/methodology/approach The paper uses a performance matched discretionary accruals
(PMDA) measure as a proxy for earnings management. Three separate panel-regressions are then
performed on a full sample, comprising a French sub-sample and a Canadian sub-sample, to detect
board characteristics and institutional features impacts on the PMDA. Regressions are based on a
panel of 180 French and Canadian listed firms data over the period 2006-2008.
Findings Evidence shows that CEO stock ownership, independent monitoring and institutional
investors property are strong earnings management determinants in both the French and Canadian
frameworks. Nevertheless, leadership structure and board size seem to be neutral. Furthermore,
French firms show specific earnings management incentives which are related to high ownership
concentration, low equity widespread and high contractual debt costs. Dominant minority ownership
and capital market forces are the key earnings management incentives in the Canadian context. These
findings are robust to alternative sensitivity tests.
Research limitations/implications Even though the findings answer some questions, earnings
management incentives are still to be decided. Future research could further highlight the impact of
contractual, legal, cultural, ethical and political country-specific factors related to financial reporting.
Originality/value This paper investigates how an effective board of directors is able to provide a
monitoring mechanism to ensure high quality of earnings. Moreover, it builds on cross-country
variations in corporate governance features and contextual-specific factors to reveal earnings
management behaviors incentives in two separate environments, namely French and Canadian ones.
The underlying promise is that poor corporate governance (weak board monitoring), high ownership
concentration, and intensive financial market forces create incentives that largely influence managers
willingness to report earnings that dont reflect a firms true performance.
Keywords Earnings management, Board of directors, Corporate governance, Discretionary accruals,
Canada, France
Paper type Research paper
1. Introduction
Following the significant increase of earnings restatements, earnings manipulation
scandals, and several high-profile bankruptcy filings by firms such as WorldCom,
The authors gratefully acknowledge comments from Wan Ong (Editorial Assistant),
Philomena Leung, Barry J. Cooper and Steven Dellaportas ( Joint Eds) and two anonymous
referees for helpful comments and suggestions.
Enron, Adelphia and Parmalat, studies on earnings management are becoming the Earnings
subject of many recent researches in financial economics. These accounting cover-ups management
have cast doubt on the reliability and the dependability of data published by companies.
Thus, can we still have trust on earnings quality? This question is increasingly asked by
both investors and regulators who call for more precise ways to control factors that
potentially causes earnings opacity. Among these factors, managerial discretion is
largely pronounced. Managerial discretion appears when some inadequacies infect the 67
agent-principal relationship or if corporate governance implements do not matter. Most
prior studies on earnings quality document that if such managerial behavior emerges,
firms true economic performance is missed. Researches in this direction have focused
on other different causes to care about a reasonable answer for the above question but
small attention has been addressed to corporate governance features. Jensen and
Meckling (1976) argue that poor corporate governance and weak financial controls leave
managers and controlling owners with considerable discretion to manage reported
earnings in order to mask true firms performance and to conceal their private control
benefits from outsiders. If so, further concern should be put into corporate governance
tools to provide evidence on the usefulness of earnings.
The board of directors is the main important tool among the different corporate
governance mechanisms. It remains the potential monitoring mechanism designed to
mitigate the inherent agency problems in the publicly traded firm. Thus, it is useful to
study its impact on the executives discretional behavior. Board oversight efficiency
with regard to such behavior depends largely on factors such as its size, composition,
independence and structure. This paper attempts to investigate the relationship between
these boardroom characteristics and earnings management being a proxy of earnings
quality in two separate countries, France and Canada. Its second aim is, however, to
investigate how specific contextual features affect differently earnings management
behavior, and which factors are the most prominent motives of management discretion
in each case. By focusing on board oversight effectiveness and specific earnings
management motives which prevail in these environments, we hope to contribute to the
extant research on earnings management and to draw firm partners attention to look
upon these motives when taking investment decisions.
The remainder of the paper is organized as follows. Section 2 develops some Canadian-
and French-specific contextual features and searches on their implications for earnings
management behavior. Section 3 provides an overview of the literature and develops the
hypothesis. Sample selection and methodology design appear in Section 4. Empirical
resultants are widely explored in Section 5. Section 6 summarizes and concludes the paper.

2. Canada-France-specific contextual features and their implications for

earnings management behavior
Canada and France belong to two different socio-economic environments which have
many distinguishing features. There is strong awareness among accounting researchers
of the influences of these distinguishable features on earnings management. We can
organize these country-specific features under three broad headings; country accounting
model, finance pattern, and corporate governance.
2.1 Country accounting model
International accounting models are commonly classified into four clusters based on
countries accounting practices similarities; Anglo-American, Continental,
MAJ South-American, and Mixed Economy (Ho and Wong, 2001). Canada and France are,
27,1 respectively, membership of the Anglo-American and the Euro-Continental accounting
models. In the Canadian accounting system, accounting posses no enforcement values
and rely more on local auditors and country-specific legal remedies to enforce flexibility
with respect to provisions to smooth income, and professionalism in the application of
rules. In such regime, regulatory requirements are less likely to determine financial
68 accounting practices, and accounting is more likely to address needs of capital
providers. The Canadian accounting system is based on a conceptual framework that
helps earnings quality improvement and safeguards shareholders interests.
Nevertheless, in the French accounting system, the financial accounting rules rely
upon the Plan Comptable in the tendency to satisfy government needs, such as
computing income taxes or demonstrating compliance with national government
policies and macroeconomic plans (Ben Othmen and Zeghal, 2006). Moreover, the French
accounting system is characterized by values of uniformity, conservatism, and statutory
control which provide appropriate standards limiting the discretionary behavior of
managers. However, France has adopted IFRS since 2005. Canada, in contrast, is very
much US oriented. IFRSs acceptance has a likely negative impact on earnings
management practices.

2.2 Finance pattern

Despite private versus government standard setters, prior studies consider bank- versus
market-oriented financial systems as additional institutional factors that influence
earnings management behavior (Ali and Hwang, 2000). Within Anglo-American
countries, of which Canada, the capital market play a major role in providing finance.
Consequently, the financial pattern is dominated by equity and shareholders impose
greater monitoring on managers to satisfy their needs for accounting information.
Hence, Canadian managers are expected to use their discretion attitude to circumvent
this pressure.
Unlike Canada, in France, as in most Continental European countries, banks among
others stakeholders, are the main suppliers of the capital needs of businesses through
loans. These partners are considered by Ball et al. (2000) as insiders and they have
private access to financial information through personal contacts and direct visit
(Ben Othmen and Zeghal, 2006). The direct access by insiders to firm information can
mitigate managerial discretion to influence earnings or contractual outcomes.

2.3 Corporate governance

The Canadian corporate governance model is a stockholder one in which management
oversight is provided by elected directors through boards committees. Monitoring in
Canada is also entrusted to financial analysis as well as to financial press. Hence,
managerial discretion behavior is likely to be significant to curb such control
constraints. However, French firms operate within a stakeholder corporate governance
model where family control is more representative. Moreover, the involvement of the
controlling owners in the management seems to be more important in France than in
many other countries around the world (e.g. on average, a member of the controlling
family is present among the top management team in 68, 45 percent in French firms
versus 34, 27 percent only in Canada) (Claessens et al., 2000). The managerial theory
shows that when shareholders are involved in the management team or have appointed
members among the top management group their influence increases. Thus, it is Earnings
expected that they would use discretion to enhance their benefits. management
3. Literature review and hypothesis development
Literature on earnings management and corporate governance oversight is sparser.
Most studies have found that earnings management can be limited when corporate
governance arrangements are well designed. Such arrangements include committees 69
independence (Klein, 2002), investors protection (Wright et al., 2006), executives
compensation (Efendi et al., 2007), institutional ownership (Hartzell and Starks, 2003),
CEOs age and tenure (Cornett et al., 2007), and board characteristics (Chhaochharia
and Gristein, 2009). There have been many surrogates to characterize board of
directors attributes including board structure, board composition, CEO/chair duality,
directors and executive stocks ownership, existence and scope of institutional
ownership, etc. The hypothesis we tested, afterwards, entailed discovering the
relationship between earnings management and such variables.

3.1 Board size

Jensen (1993) observes that when corporate boards expand beyond seven or eight people,
they become less likely to function effectively as a curb on managements discretion, and
are easier for the CEO to control. He argues that overcrowded boards are less effective,
and that small boards are preferred because skills costs are made smaller. Core et al.
(1999) show that effective monitoring is reduced when the number of directors is high
because it is easier for a CEO to capture the board, and individual board members are less
likely to be held accountable. Moreover, Yermack (1997) presents evidence that small
boards are more effective than large ones. Study on data for 1978-2001 by Uzun et al.
(2004) points out that board size is larger for fraud companies than for a matched sample
of no fraud companies. Ball and Shivakumar (2008) report a significantly monotonic
association between boards size and earnings management in the UK context. They
show that large boards are more likely associated with high earnings management
upward. Consequently, if corporate governance research recognizes the essential role of
small boards in sustaining an effective monitoring, then they would be associated with
less extent of earnings management. Hence, our first hypothesis:
H1. Earnings management is high among firms with large board of directors.

3.2 Board composition

Prior researchers show that when boards are dominated by affiliated members, agency
problems are more severe. Moreover, the standard view among governance experts is
that board independence is a necessary condition for effective governance. Accordingly,
the distinction between inside and outside directors is fundamental to understand board
dynamism. The term insider refers to both managers and controlling shareholders
(La Porta et al., 2006). Outsiders are directors who are more likely to be independent of
the firm management. Nevertheless, some so-called outside directors may have business
or family ties to management. Therefore, Fama and Jensen (1983) classify outside
directors as independent or gray. The latter may be lawyers, investment bankers,
consultants, executives of advertising agencies or family members. Outside independent
directors are board members who have no material relationship with the company,
either directly or as a partners, stockholders or officers of an organization that
MAJ has a relationship with the company (Arjoon, 2005). Earnings quality studies document
27,1 high earnings property when independent outside directors hold a significant
percentage of board seats. For example, Cheng and Warfield (2005) provide evidence
that board dependence is associated with the incidence of fraud. They found that boards
of fraud firms show fewer proportion of independent directors than non-fraud firms.
Bartov and Mohanram (2004) conclude that the less the board is independent, the higher
70 the possibility of earning management is.
Under these evidences, follows our second hypothesis:
H2. Higher independent boards are more likely to function as a curb on earnings
management.

3.3 CEO-chair duality

Dual leadership structure reduces board independence and impairs CEOs monitoring.
Fama and Jensen (1983) argued that the CEO cannot perform the chairs monitoring
function apart from his or her personal interest. Empirically, most studies support the
benefit of separated CEOs/Presidents position and observe greater associated board
effectiveness and important firms performance. Forester and Huen (2004) have shown
that CEO who acts as Chairman is more likely to be aligned with the management than
with shareholders. The dual office structure also permits the CEO to effectively control
information available to other board members, and thus may impedes effective
monitoring. CEO/chair duality can also be associated with greater use of managerial
discretion (Cornett et al., 2007). Dechow et al. (1996), Ho and Wong (2001), Xie et al.
(2003) and Eng and Mack (2003) provide evidence that firms in which the CEO also
serves as chairman showed over-statement fraud and are subject to enforcement
actions. Uzun et al. (2004) conclude that boards of directors of fraud companies are
more likely to have a CEO who serves as a chairman than are boards of directors of a
matched sample of non-fraud companies. Thus, we can state our third hypothesis:
H3. Earnings management is more widespread in firms with dual office structure.

3.4 Managers ownership

Studies (Healy, 1985; Yermack, 1997; Core and Guay, 1999; Ofek and Yermack, 2000)
present evidence to support the hypothesis that abnormal stock returns around stock
grants or stock options exercises dates occur because managers time the options/stocks
grants prior to the release of good news, thereby increasing their personal wealth. This
argument is bolstered by studies on disclosure and accounting accruals quality.
For instance, Abody and Kasznik (2000) show that CEOs receive stock option grants
shortly before the release of favorable voluntary news. They find that the disclosure
strategy (to delay the disclosure of good news and accelerate the release of bad news
around fixed equity grants dates) increases the CEOs option awards value by a mean of
$46.700. Their findings show that top-level executives use private information to time
abnormally large exercises, where the benefits from such timing are largest. Moreover,
Bartov and Mohanram (2004) find that in the pre-exercises period discretionary accruals,
but not non-discretionary accruals, are abnormally high, and that these abnormally high
discretionary accruals underlie the observed abnormally positive earnings performance
during the pre-exercise period. Their evidences are consistent with the hypothesis that,
in an effort to increase the cash payout from option exercises and sales of acquired shares, Earnings
managers manage earnings upward prior to the options exercises or shares sellers dates. management
Given the requirements above, our fourth hypothesis is therefore:
H4. The higher the managerial ownership is, the greater earnings management is.

3.5 Institutional ownership

Corporate governance researches confirm that institutional investors help reduce
71
agency costs. Hartzell and Starks (2003) show that, as investors with significant
economic stocks, institutional owners have more incentive to monitor managers than do
small investors. Researches on institutional ownership and earnings management are
several and results are somewhat similar. For instance, as noted by Klein (2002),
Cornett et al. (2007) show that the economic impact of institutional investment is
substantial; an increase of one sample standard deviation in the number of institutional
investors would decreases the average magnitude of discretionary accrual by 1.2 percent
points. Liu and Lu (2007) examine the relation between corporate governance and
earnings management from a tunneling perspective. They argue that Chine-listed
companies, with high institutional holdings, have small incentives to manage earnings
in order to meet certain return on equity thresholds, and earnings management has been
shown to be the less conspicuous. The overall conclusion is that institutional ownership
has an adversely greater impact on abnormal discretionary accruals.
We acknowledge that this leaves Hypothesis 5 in null form:
H5. Higher institutional ownership is associated with lower earnings
management.

4. Sample selection, data collections and research design

4.1 Sample selection
We focus on a sample of 240 publicly traded Canadian and French firms. The selected
sub-sample of French firms consists on all firms listed on the Paris stock market and
belonging to the SBF 250 Index. The selected sub-sample of Canadian firms comprises a
random group of firms listed on the Torontos stock exchange. To be included in the
sample, firms should have average annual sales between e4.5 and e7 million, and should
not be member of banking and insurance industries. We exclude firms in these two
industries because they are subject to special regulation as regard to board composition or
corporate governance practices. Also, their disclose policies are different due to regulatory
oversight. We also move away firms where there is missed or insufficient information to
calculate the earnings management proxys measure. Moreover, we drop the firm-year
observations with missing values in corporate governance variables. The discarding
procedure results on 720 firm-year observations as a full sample. Data are for the fiscal
years 2006-2008[1]. Table I exhibits the distribution of selected sample firms by industry
as well as by country. Per-year observations are not reported for the sake of brevity.

4.2 Data collection

All needed data are manually collected. For the French sub-sample selected firms, our
method of investigation consists on a review of Les Echos press releases to collect
financial and accounting data. These data are available in annual reports and proxy
statements sent by companies and accessed electronically on the reviews web site
 72
27,1
MAJ

Table I.
Sample selection
France Canada Full sample
Industry Two-digit SIC Number Percentage Number Percentage Number Percentage

1. Petrolium 13, 29 13 11 10 8 23 10
2. Consumer durables 25, 30, 37, 50, 55, 57 11 9 11 9 22 9
3. Basic industry 10, 12, 14, 26, 28 07 6 10 8 17 7
4. Paper product 26 13 11 10 8 23 10
5. Construction 15, 16, 17, 32, 52 10 8 15 13 25 10
6. Textiles and trade 22, 23, 31, 51, 56, 59 17 14 14 12 31 13
7. Good stores 54 8 7 9 8 17 7
8. Service 72, 73, 75, 76, 80, 82, 87 19 16 22 18 41 17
9. New economy a 35, 36, 38, 42, 79, 83 13 11 8 7 21 9
10. Other 99 9 7 11 9 20 8
Total 120 100 120 100 240 100
Notes: This table displays the breakdown of observations by industry and by country using the two-digit SIC; aare Firms belong to R&D services,
Programming, Computers or Electronic industries
(www.lesechos.fr). Data on corporate governance attributes have required detailed Earnings
researches on the companies web sites. We have also consulted the official French management
Financial Market Authoritys web site (www.amf-france.org) to exhaust data on
institutional and managerial ownership holdings.
A similar procedure was followed to collect data on the Canadian sub-sample firms.
Accounting and financial data and data on blockholders ownership were collected
from firms proxy statements available from SEDAR database. Moreover, we look into 73
firms web sites to exhaust corporate governance data.

4.3 Earnings managements measure

Drawing on the existing earnings management literature, we found that several models
have been developed to measure and predict earnings management. The common
feature of these models assumes that earnings are managed in predictable ways
throughout the manipulation of discretionary accruals (Meek et al., 2007). Discretionary
or abnormal accruals equal the difference between actual (total) and expected (normal)
accruals using a regression formula to estimate normal accruals and where total
accruals are net income minus free cash flow from operations. In this study, we use
the performance matched discretionary accruals (PMDA) measure developed by
Kothari et al. (2005) to proxy for earnings management[2].
To adjust for firm performance, we select a match sample of firms based on their
two-digit SIC code and their prior years ROA. The PMDA are the differences between
median abnormal accruals of matched sample and the sample firms abnormal accruals
estimated using the cross-sectional modified Jones (1991) model:



TAit DREVit DARit PPEit
a 1 b1 2 b2 1it 1
Ait21 Ait21 Ait21 Ait21

where:
TAit total accruals for firm i in year t;
Ait2 1 total assets for firm i from year t 2 1 to t;
DREVit change in accounts receivable for firm i from year t 2 1 to t;
PPEit gross property plant and equipment for firm i in year t; and
1it error term for firm i in year t.
Formally, the Kothari et al.s (2005) PMDA model is shown below:





TAit 1 PPEit DREVit ROAit21
b1 b2 b3 b4 1it 2
Ait21 Ait21 Ait21 Ait21 Ait21

where:
TAit, Ait2 1 PPEit2 1, and DREVit are as defined above; and
ROAit2 1 Lagged return on asset in year t of the ith firm.

For results analysis, we primarily use the absolute value of PMDA (jPMDAj),
but not PMDA, as a proxy for earnings management. Since earnings management
involves the transfer of earnings from one period to another, the jPMDAj measure
MAJ the total amount of earnings transfer without being sensitive to the precise timing of
27,1 when earnings are increased or decreased.

4.4 Control variables

In addition to the hypothesized board features effects, we also apply a variety of
control variables to minimize specification bias in the testing of hypothesis.
74 Specifically, we control for some general firm characteristics and market forces.
4.4.1 Firm characteristics.
4.4.1.1 Firm size. Watts and Zimmerman (1978) suggest that large firms face greater
political costs relative to their small counterparts. Political costs refer to costs arising
from direct or indirect regulation causing a heavy scrutiny by stock market.
Consequently, large firms may have a greater incentive to manage earnings downward
to escape from such constraints. However, Meek et al. (2007) argue that earnings
management may be lower in large firms because, compared to other firms they have
lower information asymmetry, stronger governance structures and stronger external
monitoring. We include natural log of total assets as a proxy for firm size but make no
predictions about the sign of the coefficient.
4.4.1.2 Firm performance. Cornett et al. (2007) have shown that earnings management
is more expected for failing firms than for well-performed firms. Uzun et al. (2004)
indicate that poor financial performance affect significantly the likelihood of fraud.
Ball et al. (2003) have documented negative relation between earnings surprises and firm
performance. Thus, marginally profitable firms are more likely to use abnormal
accruals. We include return on equity ratio to control for firm profitability and expect
the coefficient to be negative.
4.4.1.3 Audit quality. Jiang et al. (2008) found that higher audit quality results in
lower earnings management and improved quality of earnings. After controlling for
the auditor independence, tenure, and size, they find evidence that absolute
discretionary accruals are lower for firms audited by Big4 auditors than firms audited
by non-Big4 ones. Uzun et al. (2004) show that the higher is the degree of the auditing
process independence the lower is the likelihood of corporate fraud. Cullinan et al.
(2008) and Klein (2002) report a decreased probability of financial misstatement when
the audit committee is highly independent. To uncover the auditing quality affects on
earnings management behavior, we include the percentage of independent outside
directors in the audit committee and postulate a negative coefficient for this variable.
4.4.1.4 Industry. Ball and Shivakumar (2008) found that firms operating in
industries subject to high-price volatility or strong income sensitivity such as
high-technology industry manage earnings more frequently than companies belonging
to relatively stable industries. Meek et al. (2007) suggest that, as firms with few formal
rules, new economy companies are difficult to monitor and likely have greater
opportunity to manage earnings. We use an indicator variable to summarize firms in
new economy industries and we expect a positive coefficient for this variable.
4.4.1.5 Financial leverage. Empirical research documents that firms with financing
needs and firms approaching debt covenant default triggers have higher levels of
abnormal accruals, a higher incidence of GAAP violation and a higher likelihood
of committing accounting fraud (Weber, 2006). We use debt-to-assets ratio to proxy
for the effects of debt covenants on earnings management. The larger the firm is
leveraged, the more likely managers are to choose income decreasing.
 4.4.1.6 Foreign stock exchange listing. Foreign stock exchange listing can help Earnings
restraining upwards and downwards earnings management (Ben Othmen and Zeghal, management
2006). Firms listed on a foreign stock exchange are highly perceived by financial
analysts to be more transparent, less likely to misstate, and less tempted to manage
earnings. Transparency enforcement depends on foreigner stock market characteristics
where the firm is cross-listed. International comparisons on stock markets development
show that US stock exchange is more potent in improving monitoring and investors 75
right protection (La Porta et al., 2006; Leuz et al., 2003). If so, being listed on the US stock
market might be associated with lower managers use of discretionary accruals due to
media and investors greater breadth of scrutiny. We include a dummy variable to
control for the effects of cross-national listing. We expect the coefficient to be negative.
4.4.2 Market forces.
4.4.2.1 Ownership concentration. Bushman and Pitroski (2006) show that earnings
management practices are widespread within firms with diffuse equity, and that
executives in outsider economy are more constrained by earnings pressure than
executives in insider economy. Market issues create incentives that potentially influence
the behavior of corporate managers, investors, regulation and different other market
participants. Teoh et al. (1998a) have found high earnings management and large
sub-performance in seasoned equity offerings. Following La Porta et al. (2006), ownership
concentration is measured as the average percentage of common shares owned by
5 percent blockholders (excluding the CEO). Higher values imply higher discretionary
accruals.
4.4.2.2 Importance of equity market. Leuz et al. (2003) argue that earnings
management is frequent in countries with less developed financial markets comparing
to more developed equity markets where outside investors are provided more stringent
protection. They provide evidence that equity market importance influences earnings
management monitoring across countries. La Porta et al. (1997) point out huge
differences in the size, breadth and valuation of capital markets when comparing
developed to developing countries. They conjectured that the differences in the nature
and the effectiveness of international corporate governance systems can be traced in
part to the differences in the extent and the dynamism of financial systems. Wright et al.
(2006) conclude that widespread use of equity in countries belonging to the
Anglo-American accounting model gives rise to more earnings surprises than in other
countries. Accordingly, we expect that differences in equity market development may
have an impact on managers ability to manage earnings. Equity markets importance is
approximate by equity widespread defined as the natural log of annual countrys stock
market capitalization.
Under the preceding discussions, we develop our basic model as:

jPMDAit j b0 b1 TOTADit b2 INDEPit b3 DUALit b4 INSTit b5 MANOWit

X X
bi control variablesit gi Yeari 1it
3

where i and t denote the firm and the time subscripts. Variable definitions and
hypothesized relations with performance adjusted abnormal accruals are predicted
in Table AI of the Appendix.
MAJ 5. Results and discussion
27,1 5.1 Descriptive statistics
Panels A and B of Table II display descriptive statistics on selected Canadian and
French firms, respectively. The mean (median) PMDA, as a percentage of lagged total
assets, is 7.041 percent (5.05 percent) with the inter-quartile difference ranging from
1.4 percent to 11.91 percent for Canadian firms. The standard deviation is 5.54 percent
76 showing a small variation in jPMDAj. These values do not differ largely from the
average (median) of 5.58 percent (4.46 percent) performance adjusted abnormal accruals
shown by French firms. Canadian sample firms are relatively large with a mean
(median) natural log of total assets of 4.68 (3.84) compared to French sample firms
(Ball et al., 2000)[3]. Moreover, summary statistics show that Canadian boards of
directors are, on average, smaller, and more independent than French directories. Most
firms (59 percent) have CEO/Chair duality. Institutional ownership is presumably
considerable among Canadian sub-sample. Mean proportion of outside independent
directors in the audit committee is consistently higher for Canadian firms than for
French firms. On average, 24 percent of the outstanding common shares are held

Variable Mean Median SD 1st Percentile 3rd Percentile

Panel A: Canadian sub-sample

jPMDAj 0.07041 0.05056 0.055401 0.01405 0.11911
TOTAD 6.03 5.72 7.06 4.23 8
INDEP 0.44 0.36 0.51 0.21 0.61
DUAL 0.59 1 0.61 0 1
INST 0.24 0.18 0.33 0.09 0.42
MANOW 0.11 0.07 0.15 0.06 0.25
LTA 4.68 3.84 4.06 2.66 6.81
PER 0.09 0.05 0.14 20.16 0.36
AUDIT 0.71 0.57 0.42 0.43 0.91
IND 0.23 1 0.41 0 1
LEV 0.2 0.13 0.26 0.07 0.35
FOREIG 0.31 0.24 0.17 0.23 0.44
OWN 0.17 0.09 0.19 0.03 0.23
EW 19.98 16.3 20 14.95 23.66
Panel B: French sub-sample
jPMDAj 0.055819 0.04466 0.049315 0.018701 0.097407
TOTAD 7.35 6.75 8.31 5.5 11
INDEP 0.31 0.25 0.44 0.16 0.48
DUAL 0.77 1 0.6 0 1
INST 0.14 0.09 0.16 0.05 0.21
MANOW 0.31 0.27 0.36 0.21 0.4
LTA 4.11 3.35 5.7 1.63 7.28
PER 0.11 0.07 0.21 20.09 0.29
AUDIT 0.48 0.39 0.4 0.29 0.61
IND 0.17 1 0.27 0 1
LEV 0.34 0.24 0.41 0.16 0.53
FOREIG 0.13 0.1 0.12 0.07 0.16
OWN 0.31 0.25 0.5 0.2 0.61
EW 15.96 13.7 16.6 12.85 10.49
Table II.
Descriptive statistics Note: Variable descriptions and measurements are provided in Table AI of the Appendix
by institutional investors versus 14 percent only in French case. French managers hold Earnings
approximately one-third of overall common shares, three times larger than Canadian management
ones. One-third of Canadian firms are listed in the US stock exchange. However, nearly
80 percent of selected French firms are still listed in the local market.

5.2 Univariate relations

We first conduct univariate tests to evaluate whether performance adjusted abnormal 77
accruals vary with board of directors attributes, firm characteristics and market forces
by examining the simple correlations between these variables. Table III, Panel A reports
the Pearson correlation coefficients (in the upper diagonal) between our earnings
management measure, the set of governance variables and the main control variables for
the full sample. Pearson correlations for Canadian (French) sub-sample appear above
(below) the diagonal of Panel B Table III. The univariate differences test (t-test) appears
in Table AII of the Appendix.
Results from Table III indicate that the relationship between the jPMDAj and the
independents variables are largely as expected. Consistent with our predictions,
significant and positive associations are found between absolute PMDA and managers
ownership, leverage, and ownership concentration. The results provide evidence that
these variables are important determinants of earnings management practices. However,
we find that simple correlations between our earnings management proxy and
institutional ownership on the one hand, and board independence on the other hand, are
significantly negatives which agree with our base assumptions that these board features
are the first-order constraints of earnings management behavior. These suggestions are
hold even when we lead per-country analyses and are consistent with the findings of recent
studies (Baginski et al., 2002; Meek et al., 2007; Jiang et al., 2008; Fahlenbrech, 2009).

5.3 Regression results analysis

Pearson correlation matrix shows coefficients which are very weak implying no problems
of either heteroscedasticity or non-normal distribution between the independent variables.
Moreover, with the possible exception of board/size-firm performance correlation
coefficient (0.86 in the French sub-sample)[4], the correlation coefficients and the variance
inflation factor (VIF) statistics did not indicate any multi-colinearity problems.
Consequently, we perform a cross-sectional ordinary least-squares regression model
(equation (3)). Table IV displays the regression results.
Looking first at the full samples regression (1), we find that board attributes are
significantly related to the wide scale of abnormal accruals, with economically large
effects. Most of the coefficients on the governance mechanisms confirm the predicted
signs. Otherwise, as expected, weaker corporate governance approximated by large and
less independent boards, dual office structure, lower institutional holdings and high
manager ownership, is associated with greater earnings management. More precisely,
a one standard deviation increase in the percentage of gray director is associated with a
9.11 percent downward abnormal accruals level. Moreover, an additional one sample
standard deviation in the fraction of shares owned by the five largest institutional
investors in a firm starting from the mean value would decrease the average magnitude
of discretionary accruals by nearly 1 percent point (Cornett et al., 2005)[5]. However, the
coefficient for board size is neither as expected, nor statistically significant. Therefore, we
cannot support H1. Also consistent with our expectations, the coefficient on managers
 78
27,1
MAJ

Table III.
Pearson correction matrix
Variable 1 2 3 4 5 6 7 8 9 10 11 12 13 14

Panel A: Pearson correlation coefficients for the full sample (720 firm-year observations)
jPMDAj 1 0.05 2 0.28 20.06 2 0.43 0.21 0.12 20.1 2 0.34 0.04 0.16 2 0.11 0.09 0.12
TOTAD 1 0.03 20.01 0.11 20.04 0.1 0.01 0.03 0.01 2 0.03 2 0.03 0.01 0.01
INDEP 1 2 0.01 0.12 20.16 0.03 0.01 0.01 0.01 2 0.05 0.03 2 0.01 0.11
DUAL 1 0.1 0.21 0.01 0.06 20.01 0.01 0.04 2 0.05 0.09 0.07
INST 1 20.09 0.03 0.1 0.11 0.01 0.01 0.22 0.05 0.1
MANOW 1 20.11 0.06 20.01 0.03 0.15 2 0.01 0.13 0.11
LTA 1 0.07 0.02 0.01 2 0.18 0.1 0.1 0.2
PER 1 0.05 0.1 2 0.09 0.07 0.12 0.03
AUDIT 1 0.07 0.01 0.05 0.06 0.11
IND 1 0.1 0.01 0.01 0.01
LEV 1 0.01 0.1 0.11
FOREIG 1 0.13 0.2
OWN 1 0.26
EW 1
Panel B: Pearson correlation coefficients for Canadian (French) sub-sample are represented above (below) the diagonal
jPMDAj 1 20.01 2 0.37 0.01 2 0.14 0.23 0.08 2 0.03 2 0.12 0.2 0.13 2 0.2 0.19 0.07
TOTAD 20.07 1 0.09 0.01 0.03 20.1 0.03 0.01 0.08 0.01 2 0.03 0.02 20.05 0.08
INDEP 20.24 0.05 1 20.03 0.08 20.1 0.05 0.1 0.1 0.03 2 0.12 0.01 2 0.1 0.06
DUAL 20.01 20.07 20.05 1 20.03 0.26 0.05 0.13 20.03 0.06 0.09 0.01 0.21 0.09
INST 2 0.17 0.01 0.14 20.03 1 20.15 0.07 0.1 0.09 0.01 2 0.11 0.04 20.2 0.17
MANOW 0.11 2 0.09 2 0.1 0.31 20.06 1 0.01 0.11 0.01 0.07 0.04 0.01 0.16 0.21
LTA 0.05 0.01 0.01 0.03 0.05 0.01 1 0.05 0.01 0.01 0.13 0.01 2 0.11 0.06
PER 2 0.05 0.86 0.05 0.12 0.21 0.09 0.01 1 0.03 0.01 0.05 0.05 0.03 0.1
AUDIT 20.03 0.01 0.01 20.01 0.05 20.02 0.07 0.05 1 0.01 0.01 0.14 0.07 0.07
IND 0.01 0.01 0.03 0.01 0.02 0.01 0.01 0.01 0.01 1 2 0.03 0.01 0.01 0.01
LEV 0.26 20.03 20.05 0.07 20.09 0.1 20.01 0.13 0.01 0.05 1 0.01 0.03 20.1
FOREIG 20.1 0.02 0.01 20.01 0.06 0.02 0.01 0.05 0.03 0.01 0.01 1 0.1 0.09
OWN 0.1 20.1 2 0.11 0.27 20.13 0.02 0.17 0.05 0.05 0.01 2 0.31 0.03 1 2 0.3
EW 0.11 0.1 0.04 20.09 0.2 0.03 20.03 0.04 0.05 0.01 2 0.33 0.07 0.11 1
Notes: 1 jPMDAj; 2 TOTAD; 3 INDEP; 4 DUAL; 5 INST; 6 MANOW; 7 LTA; 8 PER; 9 AUDIT; 10 IND; 11 LEV; 12 FOREIG;
13 OWN; 14 EW; variable descriptions and measurement are provided in Table AI of the Appendix ; italic numbers indicate significance at the
1 percent one-tailed level
 Earnings
Dependent variable: jPMDAj
Independent variables Expected sign (1) (2) (3) management
Intercept NA 0.0211 * * 0.021 0.0406 * * * 0.000 0.0221 * * * 0.000
TOTAD 2 0.0153 0.161 0.0322 0.201 0.073 0.113
INDEP 2 2 0.0911 * * * 0.000 20.0659 * * 0.011 2 0.0833 * * * 0.007
DUAL 2 0.0098 0.151 20.004 0.11 0.0014 0.112 79
INST 2 2 0.0117 * * 0.037 20.266 * * 0.017 2 0.181 * * * 0.000
MANOW 0.3012 * * * 0.000 0.3346 * * * 0.000 0.396 0.14
LTA ^ 0.0411 * * 0.034 0.0721 * * 0.048 0.0581 * * 0.024
PER 2 2 0.0341 * * 0.047 0.0652 * * 0.041 0.0855 * * 0.042
AUDIT 2 2 0.021 * * * 0.004 20.014 * * 0.041 2 0.033 * * * 0.001
IND 0.0924 * 0.047 0.0713 * 0.066 0.0573 * * 0.043
LEV 0.1142 * * 0.0484 0.1529 * * * 0.000 2 0.0914 0.11
FOREIG 2 2 0.014 * * 0.037 20.007 * 0.077 2 0.021 * * * 0.003
OWN 0.0911 * * 0.038 0.1709 * * * 0.000 0.1246 0.109
EW 0.2009 * * 0.0255 0.1214 * 0.069 0.3591 * * * 0.000
Number of firm-year
observations 720 360 360
Adjusted R 2 (%) 14.53 17.57 21.11
x2 4.39 5.73 7.23
p-value 0.000 0.000 0.000
(1) Model (3) applied to the full sample
(2) Model (3) applied to the French sub-sample
(3) Model (3) applied to the Canadian sub-sample
Year dummies Yes Yes Yes
Firm-fixed effects Yes No No Table IV.
Regression analysis of
Notes: *p , 0.01, * *p , 0.05, and * * *p , 0.1 indicate significance at the 1, 5, and 10 percent the relationship between
two-tailed levels, respectively; the dependent variable is the Kothari et al.s (2005) PMDA; independent earnings management
variables are as defined in Table AI of the Appendix and board structure

ownership is positive and significant at better than the 1 percent level. Using a coefficient
estimate of 0.3012, an increase of one sample standard deviation in the manager stock
holdings raise the typical absolute value of PMDA by about 3.21 percent point. This
result is largely consistent with past researches concluding that manager ownership has
a tremendous impact on earnings management (Klein, 2002; Cornett et al., 2007). Firm
size as measured by the natural log of total assets has a positive effect on earnings
management which corroborate the positive accounting theorys claim that large firms
face greater scrutiny from investors, and thus more likely to manage earning to satisfy
their forecasts. The coefficients of the audit quality variable are negative and significant
at better than 5 percent level supporting the view that audit committee independence
have a substantial influence to reduce management discretion. Cross-country stock
exchange listings effect is also as expected. Companies listed in the US stock market are
less likely to make accruals management policies. The remaining estimated coefficients
show largely the predicted signs and are highly significant.
Models (2) and (3) exhibit similar findings, except for coefficient on board size which
changes to be positive, as expected, but remains insignificant. However, results are not
behind stable when we consider control variable interaction terms. We note that firm
characteristics and market forces effects on earnings management differ dramatically when
MAJ considering Canadian and French cases separately. Per-country analyses find prominent
27,1 evidences. On the one hand, financial leverage estimated coefficient is positive and highly
significant for French firms. On the other hand, debt-to-equity ratio shows no significant
association with earnings management for Canadian firms. More surprisingly, it has
unexpected sign. One logic explanation for this evidence is that it is consistent with the debt
covenant hypothesis expected, and so often sustained by Johnson et al. (2002); closeness to
80 debt covenant violations should be positively associated with earnings management.
Hence, according to this hypothesis, the closer a firm is to violation of accounting-based
debt covenants, the more likely the firm manager is to adopt accounting policies to raise
current earnings. This hypothesis is empirically held by several other studies focusing on
insider economy contexts (Klein, 2002; Meek et al., 2007)[6]. Moreover, model (2) reports that
ownership concentration influences significantly french managers discretional behavior.
In contrast, ownership concentration is found to have no major effect on earnings
management behavior for Canadian firms. The associated estimated coefficient is not
significant in model (3) but, it has the predicted sign. Our findings are presumably true for
the following decisive reason; contrary to the institutional French framework, the financing
pattern of Canadian firms is dominated by equity. Shareholders are the main partners of the
firm and there is obvious separation of owners and managers. Diffuse ownership structure
is associated with a dynamic and highly efficient capital market. Canadian managers are
more constrained by shareholders, financial regulators, and financial press control to
publish earnings statements that report true economic performance. In such context,
financial reporting is based on a conceptual framework that has the priority of satisfying
shareholders needs for high-quality accounting information (Ben Othmen and Zeghal,
2006). Hence, we support our prediction that Canadian firms, with large minority
shareholders are less likely to manage earnings than their counterpart French firms.
Furthermore, coefficients on equity widespread approve these findings. Natural log of
annual market capitalization displays a highly significant and negative coefficient in
model (3). Firms characterized by a dominant minority ownership are less likely than
owner-controlled firms to manage earnings. Our finding may counter prior studies showing
that managers rise earnings prior to equity offerings (Teoh et al., 1998a) or when the firm is
first introduced to the stock market (Chtoutrou et al., 2001; Ben Othmen and Zeghal, 2006).
As a robustness test of the ability of debt and market forces to predict earnings
management, we add three interactive variables as supplementary surrogates to detect
earnings management. We include LEV-country, OWN-country and EW-country to
control for differences in contextual factor. LEV-country, OWN-country, and EW-country
are, respectively, leverage, ownership structure, and equity widespread countrys
characteristics, where country is a dummy variable that takes the value of one if the
firm-year observation is French, zero otherwise. Results (not reported) are similar to these
explored above. Also, a notable observation comes from Table IV; when considering
separately Canadian and French firms, estimated coefficients on performance measure are
somewhat surprising. Regressions results show that firms ROE, contrary to our
expectations, have a significant positive effect on earnings management for both
sub-samples. To provide more evidence on the incremental growth in the value of PMDA
where controlling for firm performance, we separate each sub sample in two groups of
firms; high-profit firms, that is, firms with ROE above the 75th sample quartile, and all
other firms, which we call low-profit firms. Afterwards, we run separate OLS regressions
for high- and low-profit firms. Columns 2-5 of Table V display check regression results Earnings
separately for both specifications.
Results from columns 3 and 5 of this table show that performance adjusted abnormal
management
accruals are strongly positively correlated for the subsample of firms that have
consistently low profit. These finding corroborate the income smoothing hypothesis.
Burgstahler et al. (2006) found evidence that management of under-performed firms may
manage earnings slightly to project a smooth earnings path. Thus, they meet or beat 81
analysts forecast and/or avoid scrutiny from media and investors. Income smoothing
hypothesis is supported even if we include high and low profits as additional control
variables into the basic model.

6. Conclusion
Firms partners (e.g. investors, analysts, media, auditors) are more interested in earnings
management because it makes earnings less reliable. Less reliable earnings are harmful
for both firm and stock market reputation and can results on a potential misallocation of
resources. Recent accounting research identifies a number of earnings management
determinants. The more attention has been addressed to corporate governance
attributes such as audit type, existence and composition of committees, CEOs age
and tenure, among others. These attributes were taken separately (Klein, 2002; Uzun
et al., 2004; Cornett et al., 2007) or broadly in the shape of corporate governance scores
referred to as Gov-score (Gompers et al., 2003; Brown and Caylor, 2006; Jiang et al., 2008).
Academic research has found a close association between poor corporate monitoring
and greater earnings management. However, the majority of investigations focus on

Canadian sub-sample French sub-sample

High-profit Low-profit High-profit Low-profit
Variable firms firms firms firms

Intercept 0.061 * 0.083 * * 0.033 * * * 0.012 * * *

TOTAD 0.044 0.062 0.064 * 0.047
INDEP 2 0.07 * * 20.057 * * 20.053 * * * 20.052 *
DUAL 0.041 * * 20.014 0.047 * 0.036 *
INST 2 0.029 * * 20.033 * * 0.012 20.05 * * *
MANOW 0.093 0.056 * 0.07 * * * 0.088 * * *
LTA 2 0.014 0.021 * 0.033 0.051 *
PER 2 0.047 * * * 0.065 * * 20.047 * * * 0.044 * * *
AUDIT 2 0.04 * * 20.036 * * 20.039 * 20.027 * *
IND 0.05 * * 0.041 * 0.079 * * 0.069
LEV 2 0.027 * * * 0.041 * 20.024 * 0.063
FOREIG 2 0.01 * * * 20.07 * * * 20.09 * * 20.05 *
OWN 0.032 * * 0.045 * * 0.066 * * 0.089 * * *
EW 0.076 * * * 0.12 * * * 0.05 * * 0.042 * *
Number of firm-year
observations 203 117 172 148
Dummy year and fixed effects Yes Yes Yes Yes
Adjusted R 2 0.31 0.23 0.44 0.37
Notes: *, * *, and * * * indicate significance at the 10, 5, and 1 percent levels, respectively; Table V.
the dependent variable is the Kothari et al.s (2005) PMDA; independent variables are as defined Sensitivity analyses
in Table AI of the Appendix results
MAJ the American context. In this study, we succeed to fill this gap by examining earnings
27,1 management incentives in cross-national contexts. The underlying promise is that
a countrys financial patterns and corporate governance experiences create incentives
that largely influence managers willing to report earnings that did not reflect true firms
performance. By focusing on Canadian- and French-specific factors which shape
earnings management policies, our results are conclusive. In fact, although theoretical
82 relation among institutional factors are not well understood and hence difficult
to disentangle (Leuz et al., 2003), we find that earnings management is influenced by
several interacting factors. We show that CEO stock ownership, independent
monitoring, and institutional investors property are strong earnings management
patterns in both institutional frameworks. However, French firms show specific
incentives related to ownership concentration, less developed equity market and
contractual debt cost. Dominant minority ownership and capital market forces are the
key earnings management incentives in Canadian context. These findings are robust to
alternative sensitivity tests.
Even though our findings answer some questions, earnings management incentives
are still to be decided. Future research could further highlight the impact of contractual,
legal, cultural, ethical, and political country-specific factors related to financial
reporting. These are promising avenues of research that should be explored.

Notes
1. Fiscal year is the year covering the final month of the fiscal year chosen by the corporation.
Thus, a fiscal year from September 2005 to October 2006, for example, is considered as an
observation for 2006.
2. Adjusting for performance is important as documented by prior research. We adjust here for
performance to control for possible effects of performance volatility do to the 2007-2008
market meltdowns.
3. Not surprisingly, French firms are considerably more leveraged, with higher concentrated
ownership structure and limited equity widespread than there counterpart Canadian firms.
France belongs to the Euro-Continental accounting model where indirect finance prevails.
Within a stakeholders corporate governance model; Ball et al., notice the prominence of banks,
governments, and families as the main capital providers. In contrast, Canada prevails in the
Anglo-American accounting model, where stockholders are the principal patterns of the firm.
Equity is diffused among the public, and the capital market plays the most important role in
providing finance.
4. In order to address this potential problem separate tests, we perform without board size
variable. Results (not reported) were robust to this specification.
5. This value is close to the 1.2 percent decrease showed by Cornett et al., 2007.
6. France, along with continental European countries is an insider economy where indirect
finance is prevalent. In such environment; bank loans heavily encourage an upward
earnings management in order to avoid the violation of debt covenants. Further,
executives of leveraged firms generally opt to the continuous support of their lenders in
order to avoid an increase in capital cost. Therefore, they manage earnings upwards
to safe guard the trust of bankers or other lenders and hence continue to contract at
favorable conditions.
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(The Appendices follow overleaf.)

Corresponding author
Habib Jouber can be contacted at: jouberhabib@yahoo.fr

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MAJ Appendix
27,1

Variable Measure Predicted sign

A. Board features and ownership structure

86 TOTAD Total number of directors
INDEP Percentage of directors considered to be gray 2
DUAL One if dual office structure, and zero otherwise
INST Aggregate holding of the five institutional investors 2
with the largest number of share divided by the total
holding of all institutional shareholders
MANOW Percentage of common shares owned by the CEO
B. Firms characteristics and institutional factors
LTA The natural logarithm of total assets ^
PER ROE net income/book value of equity 2
AUDIT Percentage of independent outside directors in the 2
audit committee
IND One if new economy industry, and zero otherwise
LEV Debt-to-assets ratio
FOREIG One if the firm is listed in the US stock exchange, and 2
zero otherwise
OWN Percentage of common shares owned by 5 percent
blockholders (excluding the CEO)
EW The natural logarithm of annual stock market
capitalization
Table AI.
Variable definitions Note: Predicted sign with j PMDAj

Canada France Canada-France differences test

Variable Mean Median Mean Median Mean p Median p

jPMDAj 0.07041 0.05056 0.055819 0.04466 0.14591 * * * 0.001 0.0059 * * * 0.001

TOTAD 6.03 5.72 7.35 6.75 21.35 0.113 21.63 0.211
INDEP 0.44 0.36 0.31 0.25 0.13 0.335 0.11 * 0.0211
DUAL 0.59 1 0.77 1 20.18 * * 0.0364 0** 0.0051
INST 0.24 0.18 0.14 0.09 0.1 * * 0.0081 0.09 * * 0.006
MANOW 0.11 0.07 0.31 0.27 20.2 * * * 0.0002 20.2 * * * 0.0004
LTA 4.68 3.84 4.11 3.35 0.19 0.115 0.49 0.106
PER 0.09 0.05 0.11 0.07 20.02 * * 0.0653 20.02 * * 0.0071
AUDIT 0.71 0.57 0.48 0.39 0.23 * * * 0.002 0.18 * * 0.05
IND 0.23 1 0.17 1 0.06 0.317 0 0.0234
LEV 0.2 0.13 0.34 0.24 20.14 * * 0.0702 20.11 0.0225
FOREIG 0.31 0.24 0.13 0.1 0.18 * * 0.03 0.14 * * 0.048
OWN 0.17 0.09 0.31 0.25 20.14 * * * 0.0003 20.16 * * * 0.0001
EW 19.98 16.3 15.96 13.7 4.02 * * * 0.0000 2.6 * * * 0.0000
Table AII.
Univariate Notes: *, * *, and * * * denote significance at the 10, 5, and 1 percent, respectively; p-values are
differences test indicated in the second level
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