Corporate governance and earnings management and the relationship between economic value added and created shareholder v
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Ali El Mir is Professor of Finance, Institut Supirieur de Gestion, Tunis.
Souad Seboui* is a PhD student, Institut Supirieur de Gestion, Tunis. *Rue 41722 No. 4, Mamar Jadid, Tunis, 1007, Tunisia E-mail: [email protected]
Abstract The main interest in this paper is to test whether earnings management and governance mechanisms may help bridge the gap between accounting values, approximated by economic value added (EVA) and market values, approximated by created shareholder value (CSV). First, the results clearly show a non-significant relationship between EVA and CSV. Secondly, a positive correlation is identified between the difference (CSV-EVA) and discretionary accruals, proxy of earnings management. Thirdly, it is found that some governance mechanisms can attenuate the gap between CSV and EVA, whereas others can accentuate it. Finally, the results reveal that the different cases of convergence and divergence between CSV and EVA can be explained by governance mechanisms and earnings management. Keywords: EVA, CSV, corporate governance, earnings management
Introduction Accountants have long been interested in the relationship between market values and accounting numbers. Much of the research into this relationship has identified an important gap and a weak correlation between these two measures (Cahan et al., 2002; Chen and Dodd, 2001, etc.). This paper examines the extent to which the gap between market values and book values is reflected in
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Journal of Asset Management
firms’ corporate governance and earnings management. On the one hand, recent accounting scandals at prominent companies such as Enron, HealthSouth, Tyco and Worldcom appear to have shaken the confidence of investors. Better corporate governance of a firm, however, is considered a guarantee of the credibility of its financial and accounting reports and, consequently, a crucial criterion for
Vol. 7, 3/4, 242–254
䉷 Palgrave Macmillan Ltd 1479-179X/06 $30.00
Corporate governance and earnings management
its valuation. This is consistent the with McKinsey (2002) survey finding, showing that 15 per cent of investors consider corporate governance as more important than a firm’s financial issues, such as profit performance or growth potential. A sizeable literature (Brown and Caylor, 2005; Durnev and Kim, 2005, Drobetz et al., 2004) suggests that good corporate governance leads to higher stock returns and, consequently, to higher firm valuations. On the other hand, accounting values are largely affected by managerial practices such as disclosure timing, window shadowing and earnings management, aimed at improving the looks and the image of the firm to its stakeholders and particularly to current and potential shareholders. In Bernheim’s opinion (1999: 3), ‘any projection made from accounting numbers, no matter how reliable and neutral they may be, is dangerous and deceiving’. Given adopted accounting principles, management faces discretionary accounting decisions, which are heavily oriented to a judgment process of determining amounts, rates
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