2018 Reports

Earnings Management and Internal Control in Bank-dominated Corporate Governance: Evidence from Japan

Sakawa, Hideaki; Watanabel, Naoki

We examine the relationship between internal governance and earnings management in Japanese listed firms. Post the recent accounting frauds in large companies such as Olympus Corp. and Toshiba Corp., Japanese internal governance systems have also been widely criticized. Different from the US and UK, Japan is known as bank-dominated corporate governance system. We predict that the bank-client relationship is expected to mitigate opportunistic earnings management by mitigating the degree of information asymmetry, which is a main cause of agency problems arising from debt contracts. Our results show that bank-appointed audit board members mitigate managerial earnings management. Furthermore, neither outside directors nor audit committees (ACs) are helpful to decrease opportunistic managerial earnings management. Our findings imply that a lender monitoring system, through audit board members, could contribute by substituting the monitoring role of outside directors and ACs.