Do corporate governance practices restrain earnings management in banking industry? Lessons from India

TLDR: In this paper, the effect of corporate governance on earnings management in Indian commercial banks is examined by performing two-way least square dummy variable regression, and the results show that the number of board committees, size and independence of audit committee and joint audit are significantly effective in curbing earnings management.

Abstract: \nPurpose\nThis study aims to investigate the role of corporate governance practices in restraining earnings management in Indian commercial banks.\n\n\nDesign/methodology/approach\nEstimation of earnings management is based on discretionary loan loss provision and discretionary realised security gains and losses using Beatty et al. (2002) model. The effect of corporate governance on earnings management is examined by performing two-way least square dummy variable regression. Data for a period of five years (2016–2020) is collected from the Centre for Monitoring Indian Economy ProwessIQ database, Reserve Bank of India website, annual report of banks, National Stock Exchange and bank’s website.\n\n\nFindings\nRegression results exhibit that number of board committees, size and independence of audit committee and joint audit are significantly effective in curbing earnings management. Other board-related variables (size, independence, meetings and diligence) and audit committee variables (meetings and diligence) are not effective in restraining earnings management in Indian banks.\n\n\nPractical implications\nThe findings may prove to be helpful to regulators, board of directors and investors. It shows the weak area of corporate governance in India that is lack of autonomy to independent directors, which needs regulators attention and it also suggests that the number of independent auditors should be adequate for audit purposes. The board of directors must ensure the formulation of an adequate number of committees, which perform their own super specialised functions. This study brings an alarm to investors not to rely on reported earnings alone as they may be manipulated.\n\n\nOriginality/value\nThis paper substantiates the scant literature on the role of corporate governance practices in restraining earnings management in banks of emerging markets and to the best of the authors’ knowledge impact of joint audits on earnings management is previously unexplored in Indian banks, which are examined in this study.\n