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JABES
27,1 Board characteristics
and earnings management
in Sri Lanka
2 Shanmugavel Rajeevan
University of Sri Jayewardenepura, Nugegoda, Sri Lanka, and
Received 27 March 2019
Revised 16 July 2019 Roshan Ajward
17 July 2019
27 July 2019 Department of Accounting,
Accepted 30 July 2019 University of Sri Jayewardenepura, Nugegoda, Sri Lanka

Abstract
Purpose – The purpose of this paper is to examine the association between designated corporate governance
attributes and the degree of earnings management in selected quoted companies in Sri Lanka.
Design/methodology/approach – In total, 70 listed companies in Colombo Stock Exchange (CSE) were
selected based on the highest market capitalisation for the period covering from 2015 to 2017 and
representing beverage, food and tobacco, diversified, hotel and travel, manufacturing, oil palms and health
care sectors, which accounted for 59.9 per cent of the total market capitalisation of CSE.
Findings – This study found a positive relationship between CEO-Chair duality and earnings management.
Practical implications – The insights may also provide investors, economic analysts and regulators with
early caution indicators of potential problems in a corporation regarding corporate governance failures and
aid stakeholders in assessing the effectiveness and efficiency of the board and corporate governance structure
and earnings management methods.
Originality/value – This study extends the extant research on board characteristics and real earnings
management by adopting prominent research design and modernised data. This study offers evidence on
how selected audit and board committee’s characteristics influence real earnings management practices.
Keywords Corporate governance, Earnings management, Colombo Stock Exchange (CSE),
Audit committee characteristics, Board committee characteristics
Paper type Research paper

1. Introduction
Several multinational organisations such as Enron, WorldCom, Nortel, Parmalat and Tyco
endured corporate failure as a result of inefficient and ineffective corporate governance and
accounting malpractices (Sorensen and Miller, 2017). Sri Lanka is also prone to such
corporate collapses, large firms such as Pramuka Savings, Development Bank, Golden Key
Credit Card Company, Vimukthi Corporation and Lanka Marine Services Ltd collapsed due
to poor corporate governance mechanisms (Edirisinghe, 2015; Senarathne and Gunarathne,
2008). Prior studies provide an indication that good corporate governance attributes are
related with a lower level of earnings management, thus increasing the financial reporting
quality in developed markets (Klein, 2002; Xie et al., 2003) and in emerging markets
(Kim and Yi, 2006; Porta et al., 2000). However, there are also literature that provide
corroborative evidence indicating a negative relationship between corporate governance
attributes and earnings management (Ramachandran et al., 2015; Silva et al., 2017).

© Shanmugavel Rajeevan and Roshan Ajward. Published in Journal of Asian Business and Economic
Journal of Asian Business and Studies. Published by Emerald Publishing Limited. This article is published under the Creative
Economic Studies Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create
Vol. 27 No. 1, 2020
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 Fraud is significantly higher for firms that have previously managed earnings Board
(Perols and Lougee, 2011). Stakeholder expectation forces the management or those characteristics
charged with governance to resort to value-destroying earnings management practices or and earnings
fraudulent financial reporting (Zhao and Chen, 2008). The fraud triangle theory
substantiates that financial statement fraud occurs because of the pressures to meet management
internal and external expectations, opportunity and rationalisation (Albrecht et al., 2009).
As per the evidence found by Roychowdhury (2006) in USA and Matsuura (2008) in 3
Japan, managers use real earnings management and/or accrual earnings management to
smooth earnings.
As indicated by Rankin (2012) the board and the board-related characteristics are critical
parts of corporate structure and governance and can act as a preventive mechanism against
such earnings management malpractices.
In light of the diverse and mixed evidence available and scarcity of literature relating to
the Sri Lankan perspective, the problem statement of this research study could be
articulated as whether there is a relationship between selected corporate governance
attributes and earnings management practices in selected quoted entities in Sri Lanka.
Thus, this paper mainly aims to examine how selected corporate governance attributes such
as audit and board committee attributes impact earnings management in the selected
Sri Lankan quoted entities. Furthermore, this study examines the selected corporate
governance attributes and the level of earnings management practices.
The remainder of this study is structured as follows: the second section reviews the
extant literature. The third section describes the conceptual framework and methodology
adopted in this study. The fourth section elaborates the data analysis and results.
The conclusions are explained in the last section.

2. Literature review
This section elaborates in depth of the academic literature on the fundamental definitions,
concepts, theories, models and provisional studies conducted on the corporate governance
and earnings management.

2.1 Definition of concepts

2.1.1 Corporate governance. The Cadbury committee defines “[c]orporate Governance as a
system by which companies are controlled and directed, specifically focusing on
establishing a framework by which stakeholder interests are balanced” (Cadbury Report,
1992, p. 14). The Cadbury report provided the foremost definition of corporate governance.
“Corporate governance involves a set of relationships between a company’s management,
its board, its shareholders and other stakeholders. Corporate governance also provides the
structure via which the aims of the corporation are set, and the way of achieving those aims
and monitoring performance are determined. Enhanced corporate governance should
provide proper incentives for the board and management to pursue objectives that are in the
interests of the company and its shareholders and should facilitate effective monitoring”
(OECD, 2004, p. 12).
2.1.2 Earnings management. Lev (1989) stated earnings as disposable (net) or bottom-
line income, a distinct element in the financial accounts. The theoretical worth of an entity is
the present value of the earnings derived in the future. Better earnings represent an increase
in the entity’s value, while diminished earnings signal a decrease in the entity’s value.
In contrast to Lev’s definition, Fischer and Rosenzweig (1995) stated that earnings
management is a series of arrangements taken by the management of corporates to enhance
the present reported earnings without a corresponding growth in the long-term
lucrativeness of the corporates.

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 JABES 2.2 Corporate governance in Sri Lanka
27,1 Lakshan and Wijekoon (2012) stated that, in 1997, the Institute of Chartered Accountants of
Sri Lanka (ICASL), jointly with Securities Exchange Commission (SEC) of Sri Lanka and
Colombo Stock Exchange (CSE) developed a voluntary code of corporate governance
conduct and financial management that is similar to Cadbury report 1992 with the intention
of promoting transparency in corporate earnings. As of April 2008, there is the statutory
4 requirement by SEC, for all listed companies to abide by severe corporate governance
guidelines (Code of Best Practice on Corporate Governance, rep., 2017). Sri Lanka
established official corporate governance codes of best practices after the 1990s through its
regulatory regimes. The first real effort in codifying corporate governance practices began
in 1996 when the council of the ICASL formed a committee to make recommendations on the
financial aspects of corporate governance (Farooq and Werner, 2003). The evolution of
corporate governance codes in Sri Lanka is presented in Table I.
In Sri Lankan listed companies, there is a high level of concentration of ownership with
the existence of a controlling stakeholder and most companies are family-owned enterprises
in Sri Lanka. This raises validity concerns over the standard practices of corporate
governance based on the agency theory; in order to eliminate such high level of
concentration and abuse of family-owned enterprises, regulators should promote an optimal
ownership structure (Mapitiya et al., 2016).

2.3 Corporate governance and earnings management

2.3.1 Theoretical association between the board attributes and earnings management. Davis
(1973) (cited in Carlos and Nicholas, 1990) stated that during the sovereignty of Charles II,
1660–1688, England was crowned as an eminent trading country. The growth in foreign
trade was due to the rise of the chartered trading entities and accompanied by the fall of
controlling entities, such as Levant and Eastland companies, which had formerly conducted
the European trades. Smith (1776) (cited in Carlos and Nicholas, 1990) identified two
significant problems facing multilocational and multinational trading companies. The first
problem of control being separated from ownership and the second is how owners or
directors at home can ensure their agents are working for the benefit of the company.

Year Code Institutions Implementation

1997 The Code of Best Practice: Matters relating to Financial ICASL Voluntary
Aspects of Corporate Governance
2001 Handbook on Corporate Governance: Principles and
Guidelines to Best Practice in Sri Lanka
2002 Code of Best Practice on Audit Committees
2002 Code of Corporate Governance for Banks and Other CBSL (Central Bank of
Financial Institutions Sri Lanka)
2003 Guidelines for Listed Companies in respect of Audit and SEC and ICASL
Audit Committees
2004 Standard on Corporate Governance for Listed Companies CSE with the support of Mandatory
(Section 6 of Listing Rules) SEC and ICASL
2007 Code of Best Practice on Corporate Governance ICASL and SEC Voluntary
2008 Guidelines for Appointment of Auditors of Listed SEC
Companies
2008 The Banking Act Direction No.1: Corporate Governance CBSL Mandatory
Table I. 2008 Finance Company Direction No.3: Corporate Governance
The evolution of 2013 Code of Best Practices on Corporate Governance ICASL and SEC Voluntary
corporate governance 2017 Code of Best Practices on Corporate Governance
codes in Sri Lanka Source: Author constructed

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 Tricker (2012) suggested that there is a clear issue regarding the separation of ownership in Board
modern organisations. Owner-appointed agents will not at all times perform in the best characteristics
interest of their principals. Corporate governance practices will act as a mechanism between and earnings
owners and agents in aligning their interests, thereby mitigating the agency problem,
reducing the agency costs and improving financial performance. management
2.3.2 Empirical evidence on board and audit characteristics and development of the
hypotheses. Saggar and Singh (2017) stated that there is a significant probability of 5
disclosing positive risks in the financial statements compared to disclosing negative
risks, as the board size and gender diversity in the board are greater and are
decisive factors of risk disclosures in the financial statements. In this study, board
size is considered as a significant independent variable. Thereby, the following hypothesis
is formulated:
H1. There is an association between board size and earnings management.
Uadiale and Fagbemi (2012) stated that board with the majority of external directors
provides a better span of knowledge to the organisation and are in an enhanced place to
supervise and govern the managers, thus curtailing earnings management. In this study,
board independence is considered as a significant independent variable. Thereby, the
following hypothesis is formulated:
H2. There is an association between board independency and earnings management.
Apart from inferior expenses, CEO-Chairman duality structure can improve organisational
financial performance and financial statements quality as a sole leader can provide
unblemished direction and be more receptive to changes with concentrated authority (Chen
and Zhang, 2012). In this study, CEO-Chairman duality is considered as a significant
independent variable. Thereby, the following hypothesis is formulated:
H3. There is an association between CEO-Chairman duality and earnings management.
Vafeas (1999) stated that board meets more often during the periods of turmoil, and that
board meets more often, show improved financial performance, since board that meets more
often can allocate more time to discuss issues regarding earnings management. In this
study, the number of meetings is considered as a significant independent variable. Thereby,
the following hypothesis is formulated:
H4. There is an association between board meetings and earnings management.
In respect of financial and accounting expertise, Chen and Zhang (2012) provided evidence
that there is lesser earnings management due to the presence of independent non-executive
directors on the board and the audit committee and the accounting/finance experts on the
audit committee. In this study, the number of meetings is considered as a significant
independent variable. Thereby, the following hypothesis is formulated:
H5. There is an association between board acumen/expertise and earnings management.
Carcello and Neal (2000) stated that the presence of an audit committee is anticipated to
improve accounting practices. In this study, audit committee size is considered as a
significant independent variable. Thereby, the following hypothesis is formulated:
H6. There is an association between audit committee size and earnings management.
Xie et al. (2003) supported the notion that large audit committees with a large proportion of
independent directors, effective in monitoring earnings management and audit committee
members with financial and accounting and background should have the experience
and training to understand earnings management. In this study, audit committee

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 JABES independency is considered as a significant independent variable. Thereby, the following
27,1 hypothesis is formulated:
H7. There is an association between audit committee independency and earnings
management.
According to Corporate Governance of Malaysia, listed entities in Malaysia require as a best
6 practice, in addition to other meetings, to hold three or four audit committee meetings to
coincide with the entity’s audit cycle (Malaysian Code on Corporate Governance, rep., 2017).
In this study, an audit committee meeting is considered as a significant independent
variable. Thereby, the following hypothesis is formulated:
H8. There is an association between audit committee meetings and earnings
management.
McMullen and Raghunanthan (1996) stated that when financial experts are present in audit
committees then such organisations are less likely to face financial problems. In this study,
audit committee skill base is considered as a significant independent variable. Thereby, the
following hypothesis is formulated:
H9. There is an association between audit committee skill base in finance and
accounting and earnings management.
In the literature above, it is observed that there are several board and audit committee
characteristics that influence the level of earnings management. Mainly board
characteristics such as size and independence of the board of directors, CEO-Chair
duality, frequency of board meetings, board finance and accounting expertise,
independence and size of the audit committee, number of the meetings held by the
audit committee and its acumen in accounting and finance. Conversely, the evidence found
in the literature are mixed.
2.3.3 Control variables and earnings management. In relation to control variables,
scholars have utilised several control variables including firm size, firm growth, leverage,
being audited by the Big 4 audit firms. Evans (1987) identified that firm age is an important
element in managerial dynamics where a negative association is found between firm age
and corporate collapse. Lai and Tam (2017) stated that highly leveraged organisation has a
strong incentive to manipulate earnings to alleviate the debt clauses in their debt
agreements. Kim and Yi (2006) Suggested that there is a perception that the creditability of
an organisation’s financial statements is higher when Big 4 firms provide external
assurance on the financial statements. Carlson and Bathala (1997) stated that multinational
organisations are more probable to manipulate earnings than smaller entities, as large
entities have a range of expenditures and non-periodic items and large firms are mature and
have synchronised revenue and earnings. Ji et al. (2015) categorised firm growth as one of
the control variables in terms of earnings management and cited as an important
determinant. It is pertinent to note that there is mixed evidence on the effect of these control
variables on earnings management practices.

2.4 Theoretical and empirical gap

The above literature review shows that most of the previous studies have examined the
relationship between corporate governance and earnings management in different countries
including Sri Lanka. However, each study is unique in terms of the methodology adopted
and applied. There are numerous studies which have been carried out to explore the
association between corporate governance mechanisms and management of earnings via
discretionary accruals and real activities in developed markets. Further, another significant

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 change occurred corporate governance regulations in Sri Lanka. The Code of Best Practice Board
of Corporate Governance 2017 was jointly issued by ICASL and SEC. This has led listed characteristics
entities in Sri Lanka to make necessary corporate governance reforms. As to identify and earnings
whether new corporate governance reforms have led to better earnings management.
According to the above literature review, nine board characteristics have been identified as management
having a significant impact on earnings management.
7
3. Research methodology
This section explains the research methodology and methods adopted in this study.

3.1 Research approach

This study aims to examine the relationship between selected corporate governance
characteristics and the degree of earnings management; a quantitative approach is adopted.
Furthermore, prior research studies have (Alhadab et al., 2016; Zang, 2012) used a similar
quantitative research approach.

3.2 Population and sample

The population is all the listed entities in Sri Lanka as of 31 March 2017. The sample for the
study was selected from companies quoted in Sri Lanka, excluding insurance, finance and
banking institutions because they are highly governed by stringent rules and regulations
and follow a diverse method of the accounting treatment for their financial statements. In
selecting the sample, 100 listed companies were identified that had the highest market
capitalisation as at 31 March 2017. However, it had to be ensured that at least five
companies were available in an industry sector and therefore certain companies had to be
dropped within the 100 companies. Accordingly, 70 companies were selected. The entities
were quoted on the CSE for the period under purview (2015–2017), where the financial
period ended on March 31.
As illustrated in Table II, the beverage, food and tobacco, diversified holding and hotels
account to 50.2 per cent. The entire sample represents 59.9 per cent of the total market
capitalisation. All the financial statement data and corporate governance data were collected
from each company’s annual reports, which can be obtained from the CSE website.

3.3 Conceptual framework

Figure 1 below depicts the conceptual framework of the study, which is based on the
literature review discussed in Section 2. The conceptual framework explains the association
between selected corporate governance attributes and earnings management.

3.4 Operationalization of variable

The operationalization of the selected variables is explained in Table III.

Sector Sector market capitalisation as a % of total market capitalisation Number of firms

Beverage food tobacco 20.5 14

Diversified holding 18.9 16
Hotels and travel 10.8 14
Manufacturing 5.5 16
Oil palms 2.1 5
Healthcare 2.1 5
Total 59.9 70 Table II.
Source: Colombo Stock Exchange (n.d.) Sample selection

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 JABES Independent Variables Dependable Variable
27,1 1. Board Size Degree of Real
2. Board Independency Earnings Management

3. CEO Chairman duality

8 4. Board Meetings

5. Board Expertise
Control Variables
6. Audit Committee size
1. Leverage
7. Audit Committee 2. BIG three Auditors
Independency 3. Firm Size
8. Audit Committee Meetings 4. Growth

9. Audit Committee Skill base

in Finance and Accounting
Figure 1.
Conceptual diagram
Source: Author constructed

3.5 Analytical strategies

In order to achieve the first objective of examining the selected corporate governance
mechanisms and the level of earnings management, descriptive statistics will be used. Then,
to examine the relationship between the selected corporate governance characteristics and
the degree of earnings management, correlation analysis, ordinary least square regression
analysis and panel version of the regression analysis will be applied.
The regression model is applied as follows:
REM i;t ¼ aþ b1 SI Z E i;t þ b2 I N DBDi;t þ b3 CEOCH AI Ri;t þ b4 BMEET i;t þb5 BFAEXP i;t

þ b6 AU DSI Z E i;t þ b7 I N DAC i;t þb8 ACM EET i;t þ b9 ACFAEX P i;t þ b10 LEV i;t
þb11 BI G4i;t þ b12 FSI Z E i;t þ b14 GROW TH i;t þ ei;t :
The definitions and measurement of each variable indicated in the above equation are
presented in Table III on operationalization. The results and findings obtained by applying
above analysis strategies are discussed in the next section.

4. Data analysis and results

This section elaborates the results obtained from the statistical analysis strategies
suggested under Section 3.5. Hence, the findings of the descriptive analysis, correlation
analysis, ordinary least square regression analysis and panel version of the regression
analysis are provided along with resulting discussion in this section.

4.1 Descriptive statistics

Descriptive statistics findings are presented in Table IV, satisfy the auxiliary objectives of
the research study, which are to evaluate the selected corporate governance attributes and
the level of earnings management. Therefore, the mean value of Earnings Management
value (REMi,t) is 0.166 and the median value is 0.080, while the standard deviation is 0.210.
The results show that there is a substantial variation. On average there are eight Board of
Directors (BSIZEi,t) in the board, while three are Independent Non-Executive Directors
(INDBDi,t). Accordingly, it could be claimed that the proportion of outside directors is to the

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 Variables and denotations Measurement Related studies
Board
characteristics
Earnings management (dependent variable) and earnings
1. Earnings Management The dependent variable of this study is earnings Roychowdhury
(REMi,t) management measured using three proxies; sales-based (2006) management
manipulations (abnormal cash flow from operations),
discretionary expenses based (abnormal discretionary
expenses), and production cost based (abnormal 9
production cost). These three proxies of earnings
management were based on the model established by the
Dechow et al. (1998) and applied by Roychowdhury (2006)
Corporate governance mechanisms (Independent variables)
1. Board Size (BSIZEi,t) Total number of board of directors for firm i and period t Yasser and
Mamun (2016)
2. Board Independency Number of independent non-executive directors on the Chen and
(INDBDi,t) board for firm i and period t Zhang (2012)
3. CEO-Chair duality Coded as “1”, if CEO and Chairman roles are separated, Yasser and
(CEOCHAIRi,t) and “0” otherwise, for firm i and period t Mamun (2016)
4. Board Meetings (BMEETi,t) Number of board meetings for firm i and period t Xie et al. (2003)
5. Board Expertise (BFAEXPi,t) Number of members with financial or/and accounting Ebaid (2013)
qualifications for firm i and period t
6. Audit Committee size Number of members in the audit committee for firm i and Chen and
(AUDSIZEi,t) period t Zhang (2012)
7. Audit Committee Number of independent non-executive directors on the Abdullah and
Independency (INDACi,t) audit committee for firm i and period t Ismail (2016)
8. Audit Committee Meetings Number of audit committee meetings for firm i and Xie et al. (2003)
(ACMEETi,t) period t
9. Audit Committee Skill base Number of members with finance or/and accounting Chen and
in Finance and Accounting qualifications in the audit committee for firm i and Zhang (2012)
(ACFAEXPi,t) period t
Control variables
1. Leverage (LEVi,t) Ratio of total debt at the end of the period to the total Lai and Tam
assets at the end of the period t of firm i (2017)
2. BIG4 (BIG4i,t) Coded “1” if the auditor is a Big 4 audit firm, and “0” Chen et al.
otherwise of the firm i for the period t (2007)
3. Firm size (FSIZEi,t) Natural logarithm of sales of firm i for the period t Yasser and
Mamun (2016)
4. Growth (GROWTHi,t) Sales growth of firm i form the period t−1 to t. Ji et al. (2015) Table III.
Source: Author constructed Operationalization

standard recommended by the best corporate governance practices. CEO-Chair duality

(CEOCHAIRi,t) was observed in 72 per cent of the organisations in the sample. On average
seven Board Meetings (BMEETi,t) have been conducted by the firms in this study, which is
in line with the stipulated baseline requirements of the code of best practice.

4.2 Association between corporate governance and earnings management

4.2.1 Correlation matrix. The relationship between the two variables is indicated by
Pearson’s correlation. Table V illustrates the findings of the Pearson analysis.
It is noted that the Number of Independent Directors in the Board (INDBDi,t),
Audit Committee Size (AUDCSIZEi,t) and the Number of Independent Directors in Audit
Committee (NINDACi,t) show a significant systematic negative relationship with Earnings
Management (REMi,t) at a significance level p o0.01. Further, Board Size (BSIZEi,t) shows a
significant systematic negative association with Earnings Management (REMi,t) at

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 JABES Variablesa N Minimum Maximum Mean
27,1
REMbi,t 210 0.000 0.750 0.166
BSIZEi,t 210 5.000 12.000 8.260
INDBDbi;t 210 2.000 6.000 3.340
CEOCHAIRi,t 210 0.000 1.000 0.720
BMEETbi;t 210 2.000 20.000 7.260
10 BFAEXPbi;t 210 1.000 6.000 3.240
AUDCSIZEbi;t 210 2.000 4.000 3.100
NINDACbi;t 210 2.000 4.000 2.720
ACMEETbi;t 210 2.000 8.000 4.360
ACFAEXPbi;t 210 1.000 3.000 1.460
LEVi,t 210 0.000 0.900 0.290
BIG4bi;t 210 0.000 1.000 0.930
FSIZEbi;t 210 17.350 24.200 20.980
GROWTHbi;t 210 −0.590 0.440 0.040
Notes: aDefinitions of these variables are indicated under Table III; bThese variables were winsorized at
Table IV. 5 per cent due to the presence of outliers
Descriptive statistics Source: Author constructed

Variablesa REMi,t

1. BSIZEi,t −0.175**
2. INDBDi,t −0.211***
3. CEOCHAIRi,t 0.257***
4. BMEETi,t 0.047
5. BFAEXPi,t 0.051
6. AUDCSIZEi,t −0.264***
7. NINDACi,t −0.188***
8. ACMEETi,t −0.032
9. ACFAEXPi,t −0.002
10. LEVi,t 0.336***
11. BIG4i,t 0.103
12. FSIZEi,t 0.348***
13. GROWTHi,t 0.087
Notes: As per the results in Table VI, all the variables have a Variation Inflation Factor value less than 5,
thereby indicating that multi-collinearity issue does not violate regression assumptions or compromise the
Table V. regression model. aDefinitions of these variables are indicated under Table III. **po 0.05; ***po 0.01
Correlation matrix Source: Author constructed

significant level p o0.05. It shows that when there are more directors on the board and the
audit committee, earnings management is less likely to occur. Furthermore, it is pertinent to
note that earnings management is less likely to take place when there are more independent
directors on the board and the audit committee. CEO-Chair duality (CEOCHAIRi,t) shows a
significant systematic positive relationship with Earnings Management (REMi,t) at
significant level p o0.01.
4.2.2 Ordinary least square regression analysis. Ordinary least square regression
findings are presented in Table VI. The regression model is developed by considering the
earnings management variable as a dependent variable and corporate governance variables
as independent variables.

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 Collinearity statistics
Board
Variables a
Coef. VIF characteristics
and earnings
Intercept −0.549**
BSIZEi,t −0.009 2.382 management
INDBDi,t −0.025* 2.384
CEOCHAIRi,t 0.075** 1.206
BMEETi,t 0.004 1.221 11
BFAEXPi,t 0.033*** 1.611
AUDCSIZEi,t −0.043 2.741
NINDACi,t 0.010 2.695
ACMEETi,t −0.004 1.036
ACFEXPi,t −0.004 1.472
LEVi,t 0.285*** 1.169
BIG4i,t 0.120** 1.169
FSIZEi,t 0.029*** 1.169
GROWTHi,t 0.021 1.169
F-value 7.987
Sig. of F-value 0.000
R2 0.346
N 210 Table VI.
Notes: aDefinitions of these variables are indicated under Table III. *p o 0.10; **p o0.05; ***p o0.01 OLS multivariate
Source: Author constructed regression analysis

Kernel Density Curve (Figure A1) in Appendix 1 depicts that error terms of the model are
normally distributed, thus Ordinary least regression assumption is not violated. Ordinary
least square regression analysis shows that there is a significant systematic negative
relationship between Number of Independent Directors in the Board (INDBDi,t) and
Earnings Management (REMi,t) at significant level p o0.10, as this was substantiated under
the correlation analysis. In contrast, CEO-Chair duality (CEOCHAIRi,t) and Board Financial
and Accounting Expertise (BFAEXPi,t) show a systematic positive relationship with
Earnings Management (REMi,t) at significant levels p o0.05 and p o0.01, respectively.
This indicates that the absence of CEO-Chair duality and a smaller number of directors with
financial and accounting expertise likely to lead to lower earnings management practices.
Other selected board and audit committee characteristics do not show a systematic
relationship with earnings management.
In terms of control variables, except Sales Growth (Growthi,t), all other variables such as
Big 4 Auditors (BIG4i,t) at significant level p W0.05, Leverage (LEVi,t) and Firm Size
(FSIZEi,t) at significant level p W0.01 show a significant systematic positive relationship
with Earnings Management (REMi,t).
From the above analysis, variables such as Number Independent Directors (INDBDi,t),
CEO-Chair duality (CEOCHAIRi,t), Board Accounting and Financial acumen (BFAEXPi,t),
Big 4 Auditors (BIG4i,t), Firm Size (FSIZEi,t) and Leverage (LEVi,t) show statistically
significant association with Earnings Management (REMi,t).
4.2.3 Panel regression. The findings of the Panel regression are presented in Table VII.
As per the results of Hausman statistics for endogeneity in Appendix 2-Statistical analyses
of robustness ProbWχ2 is below the significance level of 0.05, thereby accepting the null
hypothesis of Hr0: random effects are independent of the independent variable (difference in
coefficients not systematic). Thereby to address the issue of endogeneity, panel regression
analysis is carried out with random effects and the results are presented in Table VII.
As per panel regression results in Table VII, a systematic negative associationship
between Number of Independent Directors in the Board (INDBDi,t) and Earnings

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 JABES Variablesa Coef.
27,1
BSIZEi,t −0.009
INDBDi,t −0.025*
CEOCHAIRi,t 0.075**
BMEETi,t 0.004
BFAEXPi,t 0.033***
12 AUDCSIZEi,t −0.043
NINDACi,t 0.01
ACMEETi,t −0.004
ACFEXPi,t −0.004
LEVi,t 0.285***
BIG4i,t 0.120**
FSIZEi,t 0.029***
GROWTHi,t 0.021
ProbW χ2 0.000
2
R 0.765
Table VII. N 210
Panel regression Notes: aDefinitions of these variables are indicated under Table III. *p o0.10; **p o0.05; ***p o0.01
analysis Source: Author constructed

Management (REMi,t) at significant level p o0.10. Whilst CEO-Chair duality (CEOCHAIRi,t)

and Board Accounting and Financial Acumen (BFAEXPi,t) show a statistically significant
positive relationship with Earnings Management (REMi,t) at significant levels po 0.05 and
p o0.01, respectively. All other board and audit committee characteristics are not
systematically related to Earnings Management (REMi,t). Big 4 Auditors (BIG4i,t) at
significant level p W0.05, Leverage (LEVi,t) and Firm Size (FSIZEi,t) at significant level
p W0.01 show a systematic positive relationship with Earnings Management (REMi,t).
Control variable, Sales Growth (GROWTHi,t), does not show a systematic relationship with
Earnings Management (REMi,t).
According to the robustness statistics results presented in Appendix 2- Statistical
analyses of robustness reveal that Board Independency (INDBDi,t), CEO-Chairman
duality (CEOCHAIRi,t), Board Meetings (BMEETi,t) and Audit Committee Independency
(NINDACi,t) cause an impact on the Earnings Management (REMi,t). The results of robust
standard error regression indicate that Board Independency (INDBDi,t) and Financial and
Accounting Acumen of the Board (BFAEXPi,t) show a negative systematic relationship with
Earnings Management (REMi,t), whilst CEO-Chairman duality (CEOCHAIRi,t) shows a
positive systematic relationship with Earnings Management (REMi,t). Hausman test
provides evidence that only CEO-Chairman duality (CEOCHAIRi,t) shows a positive
systematic relationship with Earnings Management (REMi,t).

4.3 Discussion of results and findings

The summary of statistical results in Table VIII indicates that only CEO-Chairman duality
(CEOCHAIRi,t) shows a consistent positive systematic relationship with Earnings
Management (REMi,t) in all statistical analyses.
In Sri Lanka, corporate governance stems from statutory regulations such as Companies
Act No. 7 of 2007 and CSE listing rules and voluntary code of corporate governance, for
instance ICASL Code of Best Practice on Corporate Governance. The selected corporate
governance characteristics in this study are in line with the stipulated baseline requirements of
the code of best practices; this is again substantiated from the evidence presented in Table IV.
However, even though compliance to stipulated requirements is achieved, there are few

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 Pearson Ordinary least Granger Hausman
Board
correlation square Panel causality Wald Robust SEs statistics for characteristics
Hypotheses matrix regression regression statisticsa regression endogenity and earnings
H1 −0.175** −0.009 −0.009 3.551*** −0.009 −0.002 management
Supported Not supported Not Not supported Not Not supported
supported supported
H2 −0.211*** −0.025* −0.025* 1.307 −0.025* −0.016 13
Supported Supported Supported Supported Supported Not supported
H3 0.257*** 0.075** 0.075** 1.657 0.075** 0.081*
Supported Supported Supported Supported Supported Supported
H4 0.047 0.004 0.004 0.118 0.004 0.000
Not Not supported Not Supported Not Not supported
supported supported supported
H5 0.051 0.033*** 0.033*** 2.353** 0.033*** 0.012
Not Supported Supported Not supported Supported Not supported
supported
H6 −0.264*** −0.043 −0.043 2.787** −0.043 −0.013
Supported Not supported Not Not supported Not Not supported
supported supported
H7 −0.188*** 0.010 0.01 1.368 0.010 0.001
Supported Not supported Not Supported Not Not supported
supported supported
H8 −0.032 −0.004 −0.004 2.791** −0.004 0.005
Not Not supported Not Not supported Not Not supported
supported supported supported
H9 −0.002 −0.004 −0.004 2.665** −0.004 0.018
Not Not supported Not Not supported Not Not supported
supported supported supported Table VIII.
Notes: aGranger causality Wald statistics lagged variables which cause an impact on the dependent variable Summary of the
do not indicate significance level. *p o0.10; **p o0.05; ***p o0.01 results of the
Source: Author constructed statistical analyses

anomalies noted. In terms of CEO-Chairman duality (CEOCHAIRi,t), 72 per cent of the firms in
the sample complied with stipulated Code of Best Practice on Corporate Governance 2017.
The code clearly indicates that two key personnel chairman and chief executive officer are at
the top of every public company – conducting of the business of the Board, and the Company’s
business. There should be a clear division of responsibilities at the head of the Company.
In total, 28 per cent of the firms in the sample do not comply with this requirement. Similar
studies carried out in Sri Lankan context are in accord with this finding in terms of CEO-
Chairman duality in firms. Senanayake and Ajward (2017) provided evidence that only 50
per cent of the firms out of 25 firms in hotel and travel sectors over the period 2013–2016 have
CEO-Chairman duality roles in the organisation which is in line with the stipulated corporate
governance requirements. Silva et al. (2017) provided evidence that 85 per cent of the firms do
not have CEO-Chairman duality roles. This may be due to the fact prominent figurehead in the
firms holding both positional power and influence over the operations of the firm and does not
want to dilute the positional power. This notion is supported by Mapitiya et al. (2016), provided
evidence that most Sri Lankan firms depict a high concentration of ownership and the presence
of a controlling shareholder. Esa and Ghazali (2012) found that the separation of the CEO and
chairman leads to a lower level of earnings management in Malaysia. Contrary to these
findings, a study conducted in China indicates that CEO-Chairman duality is not associated
with earnings management (Yang et al., 2012).
This section statistically analysed in what manner selected corporate governance
board and audit attributes influence the level of earnings management in selected

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 JABES Sri Lankan quoted entities. The statistical results above show that only CEO-Chair duality
27,1 significantly affects earnings management through real activities in selected Sri Lankan
quoted entities. The next section provides the conclusion of the study.

5. Conclusion
In terms of selected board characteristics, the results of descriptive statistics indicated that
14 most of the features of the selected board characteristics have at least complied with the
stipulated baseline level of corporate governance best practises in the selected companies.
Further, consistent statistical results in terms of CEO-Chairman duality have affected the
level of earnings management in selected Sri Lankan quoted entities. Findings support the
notion that a single figurehead both CEO and chairman positions can lead to better earnings
management practices in Sri Lankan listed entities.
The common conception is that segregation of duties is an effective internal control
mechanism. However, this study shows a positive relationship between CEO-Chairman
duality and earnings management. This may be due to the presence of a concentration of
ownership and controlling shareholder in most listed Sri Lankan entities. The presence of a
single figurehead holding both positions can detrimental to the best corporate governance
practices. Such organisations can easily manipulate earnings to gain short-term and long-
term benefits. This can be harmful to the minority shareholders. Regulators should impose
stringent corporate governance reforms to mitigate CEO-Chairman duality and protect
minority shareholders.
Finally, it should be taken into consideration that this research study is subject to certain
constraints and the results of the analyses should be interpreted upon considering those
constraints. This study has considered only certain audit and board committee corporate
attributes to assess the impact on earnings management. However, other governance
attributes might have an influence on the level of earnings management. Future researchers
could incorporate other corporate governance characteristics in order to examine their
relationship to earnings management. Second, this study has used the popular Roy
Chowdhury model to measure earnings management; future researchers can expand this
model by incorporating other variables. Finally, this research used only six sectors covering
a period of three years; therefore, the sectors and the period can be expanded.

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 Appendix 1. Kernel density curve of the error terms Board
characteristics
and earnings
Kernel density estimate management
4

17
3
Density

0
–0.4 –0.2 0 0.2 0.4 0.6
Residuals
Kernel density estimate
Normal density
Figure A1.
kernel = epanechnikov, bandwidth = 0.0345 Kernel density curve
of the error terms
Source: Author constructed

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 JABES Appendix 2. Statistical analyses of robustness
Table AI provides the results of summarised statistical analyses of robustness.
27,1

Ordinary least square regression Hausman statistics for

Granger causality Wald statisticsb with robust SEs endogenityc
Variablea Fb Coef. SE Robust SE Fixed effect Random effect
18 Intercept – −0.549** 0.228 0.204 – –
BSIZEi,t 3.551*** −0.009 0.010 0.009 0.002 −0.002
INDBDi,t 1.307 −0.025* 0.015 0.011 0.001 −0.016
CEOCHAIRi,t 1.657 0.075** 0.029 0.025 0.115 0.081*
BMEETi,t 0.118 0.004 0.029 0.003 −0.004 0.000
BFAEXPi,t 2.353** 0.033*** 0.010 0.009 −0.018 0.012
AUDCSIZEi,t 2.787** −0.043 0.030 0.030 −0.011 −0.013
NINDACi,t 1.368 0.01 0.027 0.025 0.039 0.001
ACMEETi,t 2.791** −0.004 0.009 0.001 0.010 0.005
ACFAEXPi,t 2.665** −0.004 0.021 0.017 0.010 0.018
LEVi,t 0.266 0.285*** 0.055 0.059 0.028 0.029
BIG4i,t 1.631 0.120** 0.052 0.049 0.015 0.032
FSIZEi,t 1.936 0.029*** 0.009 0.009 0.028 0.036***
GROWTHi,t 1.796 0.021 0.059 0.030 −0.009 0.000
Statistical tests for Heteroscedasticity
Breusch–Pagan/Cook–Weisberg test for heteroscedasticity χ2(1) ¼ 45.420 Prob W χ2 ¼ 0.000
White’s test for heteroscedasticity χ2(102) ¼ 137.500 Prob W χ2 ¼ 0.011
Table AI. Notes: aDefinitions of these variables are indicated under Table III; bGranger causality Wald statistics lagged variables
Summary of the which cause an impact on the dependent variable does not indicate significance level; cHRo: Random effects are independent
results of the of the independent variable (Difference in coefficients not systematic); HR1: Random effects are not independent of the
statistical analyses of independent variable (Difference in coefficients are systematic), Prob W χ2 ¼ 0.3192. *p o 0.10; **p o 0.05; ***p o 0.01
robustness Source: Author constructed

As per the results in Table AI, Granger causality Wald statistics indicate that lagged values of governance
attributes such as Number Board of Directors (BSIZEi,t), Board Accounting and Financial Acumen
(BFAEXPi,t), Number of Directors on the Audit Committee (AUDCSIZEi,t), Frequency of Audit Committee
Meetings (ACMEETi,t)and Accounting and Financial Acumen of the Audit Committee (ACFAEXPi,t) do not
cause an impact Earnings Management (REMi,t), whereas all other attributes of corporate governance do
cause an impact on Earnings Management (REMi,t ). Breusch–Pagan, CookWeisberg and White’s test for
heteroscedasticity indicate that ProbWχ2 level is below significance level 0.05, indicating the presence of
heteroscedasticity between the dependent variable (REMi,t) and independent variables (Corporate
governance attributes). The problem of heteroscedasticity is addressed by performing robust standard
errors regression model. Both ordinary least square regression (Table VI) and ordinary least square
regression with robust standard errors indicate the same coefficients; however, the standard errors are
different. Low values of robust standard errors indicate that the variance does not differ across the
independent variables (Corporate governance attributes). Accordingly, all the variables except control
variable Leverage (LEVi,t) indicate a higher robust standard error compared to standard errors. Endogeneity
is the circumstances where the independent variables are correlated with the error term; this would violate
the ordinary least square regression model. As per the results of the Hausman test, ProbWχ2 is below the
significance level of 0.05, thereby accepting the null hypothesis of Hr0: random effects are independent of
the independent variable (difference in coefficients not systematic). Thereby supporting the notion that the
independent variables are not correlated with the standard errors of the model. The independent random
effect coefficients indicate only CEO-Chairman duality (CEOCHAIRi,t) at significance level 0.05 and Firm
Size (FSIZEi,t) at significance level 0.01, which have a positive impact on Earnings Management (REMi,t).

Corresponding author
Shanmugavel Rajeevan can be contacted at: [email protected]

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