The influence of corporate governance on financial reporting is of current interest because regulators are in the process of devising and evaluating substantial reforms in the wake of recent accounting scandals. This paper investigates the relation between corporate governance and aggressive accounting and tests the existence and strength of this association.
This paper defines corporate governance more comprehensively than previous studies, acknowledging that the behavior of corporate officers is subject to many influences. Corporate governance is defined here as those measures and processes outlined by Jensen (1993): (1) legal and regulatory mechanisms, (2) internal control systems, (3) capital market mechanisms, and (4) product and factor market conditions. I test the relation between these measures of corporate governance and aggressive accounting for firms identified by the United States General Accounting Office (GAO) as having restated their financial statements because of aggressive accounting. Other researchers have simultaneously tested only selected corporate governance variables, and only against surrogates for earnings management (e.g. discretionary accruals or accounting principle choice).
