Based on the reputation and busyness hypothesis, this study aims to empirically reconnoitre the impact of board busyness on earnings management (EM). In addition, the moderating role of institutional ownership (IO) on this association is also explored.
The whole study is levelled on BSE 500 Indian listed companies for the time spanning from 2013–2014 to 2022–2023. The influence of board busyness on EM is investigated by applying a fixed-effects panel regression model, and the same methodology is followed for analysing the moderation effect, if any, cast by IO on this association.
The findings support the reputation-effect hypothesis by revealing that busy boards can inhibit EM practices. However, IO positively moderates the nexus between board busyness and discretionary accruals, suggesting a monitoring substitution failure. This indicates that both governance mechanisms, busy boards and institutional investors, rather than complementing each other, may lack coordination, which allows managerial discretion to prevail and even escalate. The findings align with the short-termism hypothesis, suggesting that transient investors may favour present-day returns irrespective of long-term governance quality, thereby empowering increased managerial discretion.
The findings related to board busyness in each empirical model substantiate the applicability of reputation and resource dependency theory, as busy directors exert a significant negative impact on EM. The networking of directors facilitates access to more resources, knowledge, expertise and the reputation associated with his name, encourages a director to adopt a strong governance mechanism and ensure quality financial reporting. Furthermore, the short-termism hypothesis is supported by the findings in Indian corporates related to the moderating role of IO. As IO positively moderates the nexus between board busyness and EM.
The study proposes insightful inferences for investors, analysts, auditors and corporate boards. The investors and analysts should carefully examine the reputation of interlocked boards and the level of activism of institutional investors in the firm when evaluating the financial reporting by the company. This facilitates the assessment of earnings quality with enhanced accuracy by financial analysts and healthier investment decision-making by the prospective investors. Moreover, the corporate boards should not rely on or delegate their oversight responsibility to any of the stakeholders, whether they are institutional owners. Rather, they should themselves closely monitor managerial discretion and maintain the quality of financial reporting by effectively controlling these practices in a timely manner.
The current study is a novel work exploring the moderating stimulus of IO on board busyness and EM alliance through the lens of the short-termism hypothesis. It is unfolding a governance vacuum which arises when networked directors shift their attention towards external responsibilities, assuming that the institutional investors actively monitor the activities. The study underscores the importance of differentiating passive, transient investors from active, long-term investors while gauging the efficacy of corporate governance mechanisms.
