Earnings Management

Earnings management and corporate governance in UK:

The role of board of directors and audit committee

Thesis Proposal by

Kang Lei

Faculty of Business Administration

National University of Singapore

CHAPTER 1

INTRODUCTION

Financial reported earnings have powerful influence on a full range of business activities of a firm and its management decisions. The earnings could either affect investors’ evaluation of the firm or impact contractual outcomes which are related to financial leverage or compensation of mangers. Therefore managers have strong intentions to adjust earnings numbers to the desirable level. The flexibility of current accounting principles also provides managers with considerable ability to adjust accounting earnings. The practice that the management uses judgment in financial reporting and in structuring transaction to alter financial earnings is called “earnings management” (Healy and Wahlen (1998)).

Although earnings management problem is not new, the recent popularity of earnings manipulation has drawn serious attention from regulators, financial press and academic research. For example, in a speech at NYU Center of law and business in 1998, Author Levitt, the Chairman of U.S Securities and Exchange Commissions (SEC), said earnings management impaired the quality of financial reporting. His comments showed serious concern of the adverse consequence of earnings management to the US capital market. Earnings management could also be undesirable to shareholders. When the interests of shareholders and mangers diverge, mangers can manipulate earnings for their own purposes at the cost of shareholders’ interest. Hence how to improve the reliability and integrity of financial reporting is an interesting topic for research.

Corporate governance mechanisms, board of directors and audit committee in particular, are responsible for monitoring managers on behalf of shareholders and overseeing financial reporting process by company...