Corporate Governance Influence on Earnings Management in Latin America

This report, published in the Journal of Business Ethics, examines the relationship between corporate governance and earnings management in Latin American markets from 2006-2009. The study investigates how internal corporate governance mechanisms, such as the role of external directors and board meeting frequency, influence the use of discretionary accruals. It also explores the impact of ownership structure, including insider ownership and ownership concentration, on earnings quality. The research reveals the limitations of external directors and suggests that frequent board meetings lead to more active monitoring. Moreover, the study highlights a non-linear relationship between insider ownership and discretionary accruals. The research also extends to ethical aspects, analyzing the impact of country governability levels, such as corruption control, rule of law, and government effectiveness, on earnings management behavior, with the findings indicating that improved governance reduces earnings management practices. The findings contribute to the understanding of corporate governance in emerging markets and have important policy implications.

Does Corporate Governance Influence Earnings Management
in Latin American Markets?
Jesus Sa´enz Gonza´lez• Emma Garcı´a-Meca
Received: 7 May 2012 / Accepted: 27 March 2013 / Published online: 26 April 2013
Ó The Author(s) 2013.This article is published with open access at Springerlink.com
Abstract Although US and European research has doc-
umented improvement in earnings quality associated with
corporate governance characteristics, the situation in Latin
America is questionable, given the business environment in
which firms operate,which is characterized by controlling
family ownership and weak legal protection.The purpose
of this study is to examine the relation between the internal
mechanisms of Corporate Governance and Earnings Man-
agementmeasured by discretionary accrual.We use a
sample of listed Latin American non-financialcompanies
from the period 2006–2009.Our results show how in the
Latin American contextthe role ofexternaldirectors is
limited and that Boards which meet more frequently take a
more active position in themonitoring ofinsiders,so
showing a lower use of manipulative practices. In addition,
we find a non-linearrelation between insiderownership
and discretionary accruals,also pointing to the factthat
ownership concentration may be a manipulative practices
constrictor mechanism only when the ownership of main
shareholdersis moderate.The findingshaveimportant
policy implicationssince this is, to the best of our
knowledge,the first study to analyze the relation between
the effectivenessof the governmentand the earnings
managementbehavior.As policy implications,we docu-
menthow when a country implements controls aimed at
reducingcorruption,strengtheningthe rule of law or
improving the effectiveness of government, this leads to a
reduction in firm earnings management.
Keywords Board of Directors Corporate governance
Corruption Discretionary accruals Ownership structure
Introduction
In recentyears large accounting fraud uncovered in the
stock markets has once again confirmed the existence of
ethicalfailuresand the importance oftransparency and
reliability of the financial information provided to markets
(Lang and Lundholm 2000).The regulatory response to
financialscandalshasbeen to take measuresto protect
information transparency, mitigate conflicts of interest and
ensure the independence of auditors, all in order to protec
the investorsinterests’and increasethe confidenceof
capitalmarkets (Leuz etal. 2003).A weak governance
structuremay providean opportunity formanagersto
engage in behavior that would eventually result in a lower
quality of reported earnings, which is a strong indication o
a serious decay in business ethics.
Since the studiespublished by Jensen and Meckling
(1976) and Fama and Jensen (1983),it has been assumed
that both, the role of the board of directors and ownership
structure,are crucial in monitoring managerial activity,as
they are capable of reducing agency costs resulting from
the alignmentof ownership and managementinterests.
Thus, severalstudiesdocumenta significantrelation
between the characteristics of the board of directors and t
integrity of accounting information (Rahman and Ali 2006;
Patelli and Prencipe 2007; Hashim and Devi 2008).Some
other studies analyze the effectof the internalownership
J. Sa´enz Gonza´lez
Accounting and Finance Department,Universidad Auto´noma
de Ciudad Jua´rez,Ciudad Jua´rez,Mexico
e-mail: [e-mail]
E. Garcı´a-Meca (&)
Accounting and Finance Department,Business Faculty,
Technical University of Cartagena,c/Real 3,
30201 Cartagena,Spain
e-mail: [e-mail]
123
J Bus Ethics (2014) 121:419–440
DOI 10.1007/s10551-013-1700-8

and shareholding concentration held by major shareholders
on the quality of financial results (Lefort 2005; Kim and Yi
2006; Price et al.2006).All these studies relate mainly to
Anglo-Saxon countries,where outside investors are well-
protected by the legalsystem (e.g.,United States,United
Kingdom), the level of transparency is high and most listed
firm’ present widely held ownership structures.
The above scenarios cannot be readily applied, however,
to the case ofLatin America and many othercountries
characterized by weak legalprotection of minority share-
holders’ interests and concentrated ownership structures. In
the Latin American context,the ownership structure of
listed firms is characterized by high levels of concentrated
ownership where many firms are directly controlled by one
of the industrial or financial conglomerates that operate in
the region (Lopez and Saona 2005; Cespedes et al.2008),
through the use ofpyramidalstructures thatenable con-
trolling shareholders to separate their voting and cash flow
rights(Mendesand Mazzer2005),and by the notable
presence of family groups among such owners (La Porta
et al. 1999;Castan˜eda 2000a,b; Rabelo and Coutinho
2001; Santiago et al. 2009). Moreover, the control exerted
by these family owners is not usually limited solely to their
participation in the firms’ownership since they usually
play an active role in management (La Porta et al.1999).
Additionally, Boards of Directors in Latin American firms
are notas independentas those in developed countries,
making them lesseffective in monitoring the decisions
taken by managers (Santiago and Baek 2003; Lefort 2005;
Helland and Sykuta 2005).
According to the approaches setout,this paper’s main
objective is to analyze the relation between the internal
mechanisms ofCG and EM in firms listed on the main
Latin American stock markets, specifically, on the markets
of Argentina, Brazil, Chile, and Mexico, during the period
2006–2009. These countries have not been strangers to the
initiatives ofpractically allWestern countries since the
promulgation in 2000 of the Sarbanes–Oxley in the U.S.
and it seems appropriate to verify empirically the effects of
CG mechanisms such as ownership structure and board
of directors in these countries. Therefore, another objective
of this paper is to analyze the relation between board and
earnings managementin this type of context,where both
the predominantagencyconflictand the institutional
environmentdiffer from those in the Anglo-Saxon and
Continental European markets.
The specific characteristics of Latin American countries
make italso interesting to analyze the country govern-
ability level,because corruption is prevalentin emerging
countries,affecting the effective function of governments
and economies (Gilland Kharas 2007;Aidt 2009).The
implementation of controls aimed atreducing corruption,
to strengthen the rule of law or to improve the effectiveness
of the government in a country could lead to a reduction i
opportunistic behavior and, consequently, could reduce th
earnings management practices in firms.Thus,by using a
governmentindex proposed by the previous literature we
will testif those countries thatcontrolcorruption have a
strongerrule of law and highereffectivenessof their
governmentreduce the earningsmanagementbehavior.
This study contributes to the growing body ofliterature
related to CG in the following ways.First,it extends the
very limited research on the relation between CG and EM
in Latin America and providesa more comprehensive
pictureof this association.Second,it providesfurther
evidence by analyzing the empiricalevidence in a Latin
American context,where the Boards ofDirectors,legal
investors’protection,the presence ofreference investors
and the threatof corporate takeoverdiffers substantially
from other regions of the world,especially in those coun-
tries with developed markets.Third, our study extends the
literature to ethicalaspects thatare scarce and have not
been tested yet in the relation between the internal mech
anisms of CG and EM in Latin America,such as corrup-
tion,rule of law,and government effectiveness.
The remainder of the paper is organized as follows:in
nextsection,the study hypotheses are developed; in third
section,we present the design and research methodology;
in fourth section,we show the statisticalresults;in fifth
section,we discuss the results,the limitations,and future
lines of research and; finally, in last section we present the
main conclusions of our study.
Previous Literature and Development of Hypotheses
Ownership Structure
Ownership structure is an internal control mechanism that
focuses on the aspects thatdefine the ownership ofthe
company and refers to the manner in which titles or rights
of representation redistribute the capital of the company i
one or more individuals or legalentities.The monitoring
powerderived from the ownership structure results in a
kind of controlexercised over the company and,particu-
larly,over the top management team.
Previous studies mainly focus on the effectof insider
ownership on the EM (Sanchez-Ballesta and Garcia-Meca
2007;Teshima and Shuto 2008),along with ownership
concentration (measured by the fraction of ownership held
by major shareholders or by the proportion of ownership h
by the main shareholders of the firm) (De Miguel et al. 200
Boubrakiet al. 2005).However,Demsetz and Villalonga
(2001)affirm thatin orderto treatownership structure
appropriately and to account for the complexity of interes
representedin a given ownershipstructure,different
420 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

dimensionsof ownership structure mustbe considered.
Following this suggestion, we analyze apart from these two
common dimensions examined by previous literature,two
different dimensions of ownership structure that the litera-
ture has also shown could be an effective CG mechanism in
monitoring management decisions, able to constrict manip-
ulative practices and, consequently, improve earnings qual-
ity: family ownership (Wang 2006;Ali et al. 2007;Bona
et al. 2008) and institutional ownership (Ferreira and Matos
2008; Ruiz et al. 2009; Ferreira et al. 2010). The next sections
describe the development of the hypotheses related to the
four ownership structure variables examined in our study.
Internal Ownership
Agency Theory suggeststhat when managersare not
owners ofthe entity thatthey lead orthey have a low
equity stake in it, their behavior is affected by self-interest
that is far from goals of maximizing corporate value and,
therefore,from the interest of shareholders,and this facil-
itates EM (Jensen and Meckling 1976;Fama 1980;Fama
and Jensen 1983; Healy 1985; Holthausen et al.1995).In
contrast,if managers have a certain proportion oftheir
wealth materialized in shares ofthe company thatthey
lead,or their personalwealth directly dependson the
decisions taken will tend to align, to a greater extent, their
interests with other shareholders (convergence of interests’
hypothesis) and show less discretionary behavior (Mehran
1995; Alonso and De Andre´s 2002).Thus,insider owner-
ship can be seen as a way to constrain the opportunistic
behavior of managers, so the level of discretionary accruals
is predicted to be negatively associated to insider owner-
ship (Wartfield etal. 1995).However,excessive internal
ownership may also have an adverse effecton the com-
pany, because the higher power of the managers could lead
them to take accounting decisionsthatreflectpersonal
reasons,so affecting the goalof maximizing the value of
the company (Yermack 1997; Aboody and Kaznik 2000).
Machuga and Teitel(2009) analyze earnings quality sur-
rounding the implementation ofCode ofBestCorporate
Practices for a sample of Mexican listed companies,and
find thatfirmswith internalownership show a greater
earnings quality compared to those that do not have man-
agerial ownership.
Therefore,the argumentthatinsiderownership con-
strains the opportunistic interestof managers suggests a
negative relation between the proportion of shares held by
insiders and the absolute value of discretionary accruals.
We address this view by testing the following hypothesis:
H1 Insider shareholding negatively affects earnings man-
agement.
Ownership Concentration
Large shareholders play a key role in internalcontrolof
companies, because the volume of participation encourag
them to monitor and influence the strategy of the firm in
which they have invested (Fernandez 1998;Yeo et al.
2002;Gabrielsen etal. 2002).This means thata greater
ownership concentration should,according to the efficient
monitoring hypothesis (Jensen and Meckling 1976), lead to
a less opportunistic behaviorand a greatertendency to
maximization the value of the firm (Fama 1980; Fama and
Jensen 1983),having a positive impacton the informa-
tiveness of accounting earnings,since increasing the par-
ticipationof the controllingshareholderreducesthe
incentivesof this ownerto expropriatethe wealth of
minority shareholders (De Miguelet al. 2004;Boubraki
et al.2005). In this sense, De Bos and Donker (2004) point
out that increased ownership is an effective CG mechanism
in monitoring accounting decisions taken by management
and implies a higher earnings quality.
Yeo et al. (2002) deal with the monitoring role played by
external unrelated block holders, which reduces the oppor
tunities of earnings management,and de Bos and Donker
(2004) also show that increased ownership concentration
an effective corporate governance mechanism in monitori
accounting decisions of incumbentmanagement,such as
voluntary accounting changes. However, when the level o
ownership concentration is too high it can lead to agency
problems due to the expropriation of the minority share-
holders’ interests (Boubraki et al. 2005; Lefort 2007). In th
paper we supportthe efficientmonitoring hypothesis and
suggest a negative association between ownership concen
tration and earnings management:
H2 Ownership concentration negatively affects
earnings management.
Family Ownership
Severalstudies have shown how certain distinctive char-
acteristics of family firms have a positive impacton cor-
porate behavior.Anderson and Reeb (2003) suggestthat
the long-term ties typicalof the family owner mean that
external agents,such as suppliers or lenders, develop their
business with the controlling family over a long period of
time.This leadsto theseexternalagentsperceiving a
‘‘family reputation’’ thathas economic consequences that
lastnotonly for the owners’ lifetime,butthroughoutthe
lives of his/her heirs.In the same line,Wang (2006) and
Ali et al.(2007) states that long-term orientation and rep-
utationconcernsmeansthat family firms do not act
opportunistically in reporting earnings,such thattheir
actions are more in line with a short-term orientation.
Does Corporate Governance Influence Earnings Management in Latin American Markets? 421
123

At this point, it could be concluded that, compared with
non-family firms,controlling family firms would tend to
maximize the firm’s wealth in the long term.Thus,there
would be fewer incentives to obtain private benefits at the
expense ofminority shareholders,which in turn could
resultin a higherearningsquality (Bona etal. 2008).
However, Wang (2006) and Ali et al. (2007) also point out
that one of the main limitations of their studies is the dif-
ficulty in extending theirresults to othersettings where
there is a lower protection of minority shareholders,and
consequently,more concentratedownershipstructures,
such as Latin America.This is because the presence of
concentrated ownership structuresand thepresenceof
family groups may trigger other problems of CG.In this
sense,when there are large shareholders in firms there is
more likelihood of conflicts arising from interests between
these parties and the minority shareholders. In family firms,
given their greater information asymmetries, the likelihood
of expropriation of corporate resources is high,including
the likelihood ofentrenchmentof an unskilled family
management team (Mcvey and Draho 2005; Sacristan and
Gomez 2007).
According to this argument,Castrillo and San Martı´n
(2007) study the relation between ownership structure and
the Board ofDirectors with managerialdiscretion fora
sample of Mexican companies,and find thatfamily own-
ership and the levelof corporate leverage explain the
degree of discretion thatmanagers have for manipulating
accounting numbers in Mexico. Other studies on the Latin
Americancontext,such as Castan˜eda (2000a,b) and
Rabelo and Coutinho (2001) show that a high family par-
ticipation exertsa decisive influence on the controlof
companies, where the owners are usually issued non-voting
sharesand develop pyramidalownership structuresto
obtain funds without dispersing their capacity to control the
companies.According to previous arguments,it could be
argued that the greater concentration of voting rights could
entailgreaterincentivesfor controlling shareholdersto
obtain private benefits,i.e., increasing EM (Bona etal.
2008).
Therefore, the argument that high levels of family own-
ership can lead to agency problems due to the expropriation
of the minority shareholders’ interests in Latin America,
suggests a positive influence on earnings management:
H3 Family ownership positively affectsearningsman-
agement.
Institutional Ownership
Institutionalinvestors plays an active role in controlling
managerialdiscretion and improving theefficiency of
informationin capitalmarkets,as the investorsare
sophisticated with advantages in acquiring and processing
information (Balsam etal. 2003;Koh 2003;Ferreira and
Matos 2008;Ruiz et al. 2009;Ferreira etal. 2010),so
limiting opportunism andpromotingthe reductionof
agency costs (Shleiferand Vishny 1997;Rajgopalet al.
2002; Chung et al. 2002). In this way, Koh (2003) and Hsu
and Koh (2005)proposethat the role of institutional
investors in firms can be approximated by considering the
levelof participation ofthe institutionalshareholders in
them,i.e.,thatinstitutionalownership may actas a gov-
ernance mechanism that affects the EM based on the leve
of their participation.Specifically,low levels of investor
participation are assimilated to temporary orshort-term
views,whereas when the levelof participation increases,
the institutional investor is assimilated to an investor more
engaged with the company,and hence,involved in the
resolution of conflicts that may arise therein.
In Latin America,Lefort (2005) points out that institu-
tionalinvestors have an importantrole in CG of compa-
nies.The early reform ofthe pension fundsin Chile,
followed later by Argentina, Colombia, Peru, and Mexico,
gave institutional investors an important role as providers
of capitaland prompted severalchanges to the laws of
capitalmarketsin the region;it helped to substantially
improve the protection of minority shareholders (Iglesias
2000),given the nature offunds administered and their
political influence.
Therefore,the argumentthat a higherinstitutional
ownership should lead to a positive impacton corporate
behavior,because the managers would be discouraged to
make EM due to the pressure from institutional investors t
focus in long term, suggests a negative relation between t
proportion of shares held by institutionalowners in Latin
America and the absolute value of discretionary accruals.
H4 Institutional investors negatively affect earnings man
agement.
Board of Directors
The Board of Directors is the governance body to which
shareholdersdelegatethe responsibilityof overseeing,
compensatingand substitutingmanagers,as well as
approving major strategic projects. It therefore plays a key
role in the overalloverseeing ofthe company and the
monitoring oftop managementin particular(Jensen and
Meckling 1976; John and Senbet 1998; Daily et al.2003;
Chatterjee et al.2003).Thus,the Board of Directors is an
essential element of CG and is considered the main intern
mechanism in reducing agency conflicts,eitherbetween
managersand shareholdersor betweenmajorityand
minority shareholders (LaFond and Roychowdhury 2006;
De Andrade et al.2009).
422 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

The CG literature shows differentcharacteristics that
may influence the effectivenesswith which the Boards
monitor the performance of managers in firms (John and
Senbet 1998; Rahman and Ali 2006).However,according
to Fernandez et al.(1997),most of the previous CG liter-
ature discusses mainly two characteristics or variables that
influencethe monitoringcapabilitiesof Boards:their
independence and size.As well as these two characteris-
tics,we analyze its activity and the CEO duality or con-
centrationof power.The next sectionsdescribethe
developmentof the hypotheses related to the four Board
characteristics examined in our study.
Board Size
Studies such as Davila and Watkins (2009) in Mexico and
Ferraz etal. (2011) in Brazil,find thatif the size of the
Board is very small,the monitoring ofthe management
team is smaller too, so they tend towards greater discretion
in receiving higher remuneration,a greater chance of EM
and are more prone to information asymmetry (Fernandez
1998; Azofra et al. 2005; Brick et al. 2006). Thus, a larger
size of Board assumes a bettersupervision ofthe man-
agementteam and a higher quality of corporate decisions
(Pearce and Zahra 1992).In this sense,Chin et al.(2006)
for a sample of 313 firms from Hong Kong,found a neg-
ative relation between the size ofthe Board and EM,
concluding that a larger Board fewer are the manipulative
practices made by the management of companies.
However,excessive size can be an obstacle for quick
and efficient decision-making,due to problems of coordi-
nation and communication.Santiago and Brown (2009)
take a sample of 97 companies in Brazil, Chile, and Mexico
and find a positive relation between the size of the Board
and EM. This indicates thatthe low separation between
ownership and control that exists in Latin American com-
panies assumes that with a larger size of Board the levels of
monitoring of the management team decrease,so increas-
ing the risk ofexpropriation by controlling shareholders
and the propensity to the discretion of the board members
to establish a higher level of remuneration and manipulate
the results of companies for their own benefit(Fernandez
et al.1997; Core et al.1999; Thomsen 2008). We support
this last view and pose the following hypothesis:
H5 Board Size positively affects earnings management.
Board Independence
Because previous CG literature shows that independence is
often considered as a substitute for transparency and dis-
closure of annualreports,it has often recommended that
the number of externalmembers in board of directors be
greater than the owners,for there to be more oversight of
management and to maximize the value of the organizatio
(Zattoniand Cuomo 2010;Ferraz etal. 2011).This sug-
gests thatthe degree ofBoard independence is directly
related to thequality of information thatfirms issues
(Cheng and Courtenay 2006).Also, CG literaturehas
affirmed thata greaterdegreeof Board independence
provides more controlover the developmentof company
activities and a better defence of the issue of information
a mechanism to carry outprocesses ofaccountability to
differentgroups of business interest,because the external
directors are notlinked to the managementof the entity
(Willekenset al. 2005;Karamanou and Vafeas2005;
Cheng and Courtenay 2006).Therefore,Board indepen-
dence seeks fairness in the strategic decisions taken by th
Board and effectivemonitoringof the decisionsand
activitiesof managers,thus ensuringtransparencyof
information and proper image on the outside of organiza-
tions (Chen and Jaggi2000;Patelliand Prencipe 2007).
Furthermore,severalstudiesprovide empiricalevidence
relating to the role of external directors on the constriction
of EM, documenting thata higher proportion of external
directors,will mean greater and better quality of financial
information issued by firms, so reducing the chances of EM
(Xie etal. 2003;Davidson etal. 2005;Garcı´a Osma and
Gill de Albornoz 2007;Bradbury etal. 2006;Jaggiet al.
2009).
Mostrecentstudies such as Price etal. (2006,2007),
Teiteland Machuga (2008),Chong etal. (2009),Davila
and Watkins (2009),and Ferraz etal. (2011) show thata
legalframework in capitalmarkets (such a Code of Best
Corporate Practices)has forced Latin American firms to
include more externaldirectors,so making itpossible to
improve the way thatfirms disclose their financialinfor-
mation,and they therefore show a greater transparency in
theirreports and decrease the chances ofEM. From the
above,we formulate the following hypothesis in the sense
thata possible negative association could be expected
between the degree of Board independence and EM.
H6 The Boards independence affects negatively on earn-
ings management.
Board Activity
Another characteristic related to the Board of Directors is
its activity, measured by the number of meetings, since its
size and independence are necessary butnot sufficient.
Thus, Adams (2003) and Garcia Lara et al. (2009) suggest
thatthe numberof meetingsis a good proxy forthe
directors’monitoringeffort. As Menon and Williams
(1994) notes that Boards that do not meet,or meet only a
few times,are unlikely to be effective monitors.In this
Does Corporate Governance Influence Earnings Management in Latin American Markets? 423
123

way,Eguidazu (1999) argues thatit is also essentialthat
the Boards be active and understand their task as a con-
tinuousprocess,and Vafeas(1999)has demonstrated
empirically the existence of a directrelation between the
Board activity and the profitability of the firm.In conse-
quence, it is possible that Boards that are more engaged in
their duties take a more active stance in order to safeguard
the quality of accounting information,so, in principle,a
negative relation between the Board’s activity and EM is to
be expected (Monterrey and Sa´nchez 2008).An opposing
view is thatBoard meetingsare notnecessarily useful
because routine tasks absorb much of the limited time that
directors and CEO’s spend together to setthe agenda for
Board meetings (Lorca etal. 2011).Based on the above,
we formulate the following hypothesis in the sense that a
negative association between the Boards activity and EM
could be expected.
H7 A greater numberof Board meetingsinfluences
earnings management negatively.
CEO Duality
It is understood thatthere is concentration of power in a
company when the same person takes the role ofchief
executive and presidentof the Board.Someempirical
studies developed in Latin America show thatin practice
this separation is not fulfilled, despite the recommendations
of the Codes of Good Governance.There is a high con-
centration of ownership and controlheld by families that
produces an effectof entrenchmentby the chairman of
Board of Directors when he maintains family ties with the
majorshareholders.In this sense,in Mexico,Castan˜eda
(2000b) found thatin 85 % of Mexican companies listed
on the Stock Exchange in New York the majority owners
preside the Board of Directors and also exertthe role of
CEO. However,Husted and Serrano (2002)arguesthat
while in Mexican firms, the family retained both functions,
a group of them showed that the majority owner delegated
the role ofgeneralmanagerto a family member,which
responds to succession process and the need to provide a
resource management for the business trust (Hoshino 2004;
Ruiz-Porras and Steinwascher 2007).
Also, Leal and Carvalhalda Silva (2005)in Brazil,
through the application of surveys on a sample of 400 listed
companies,documented that36 % of companieshave
powerconcentrated in thesameperson.In Argentina,
Chisari and Ferro (2009) for a sample of 100 listed firms,
find that in 75 % of the corporations the chairman and CEO
are the same person. This situation is not very different in
Chile; Lefort and Walker (2005) obtain similar results in a
sample of 120 listed companies,pointing out thatonly in
21 % of corporationsis the Chairmanof the Board
independent,thatis, there is no duplication offunctions
between President-CEO,a situation thatis widespread
throughoutLatin America.Based on the above,we for-
mulate the following hypothesis in the sense that a positiv
associationbetweenCEO duality and EM could be
expected.
H8 The existenceof concentrationof power (CEO
duality) increases earnings management.
Government Index
While corruption is prevalent in emerging countries,there
is increasing focus on the degree ofits predictability to
affect the effective functioning of governments and econ-
omies (Gill and Kharas 2007; Aidt 2009).Voliotis (2011)
look at different forms of organisational corruption in the
European Union;Galang’s (2011) study reviews the cor-
ruption literature in leading managementjournals while
Dela Rama (2011) looks at how the CG of family-owned
business groups, deals with different forms of corruption in
Asia. However, literature regarding ethical aspects on Lati
American countries is scarce and the effects on discretion
behavior have not been tested yet.
Thus, we use the Government Index (GOV_Index) taken
from the research project ‘‘Worldwide Governance Indica-
tors’’(WGI)1 proposed by Kaufmann etal. (2010)and
publishedby the world Bank2 betweenthe periods
2006–2009. We integrate this index using three main indi-
cators that previous literature has shown as very importan
factors in measuring the way in which the governability of
country helps to reduce or increase opportunistic behavior
firms:controlof corruption,rule of law,and government
effectiveness (Aidt 2009; Voliotis 2011; Galang 2011). Low
levels of governability (a low index value) imply, generally
behaviors that affect the trust placed in public officials and
therefore, undermine the basis of government trust (Shlei
and Vishny 1993). The presence of corruption, the lack of
confidence, and respect of the agents in the quality of con
tractenforcement,property rights,courts,as wellas the
ineffectiveness of governments in the implementation and
formulation of policies,increase the risks of the entrepre-
neur, because people from outside the value chain may ha
opportunistic behavior and take advantage of their profits
1 This indicator reflects the traditions and institutions over which the
authority in a country is exercised,including the process by which
governments are selected, monitored and replaced, the government’
ability to formulate and implement effective policies,and respect of
citizens and the status of the institutions that govern their economic
and socialinteractions.The governance indicators cover 213 coun-
tries and are based on 33 sources thatinclude a collection of more
than 120,000 responses from citizens,experts,and companies from
around the world (Kaufmann et al.2010).
2 Available at www.worldbank.org.
424 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

situation that is feasible due to the relatively high levels of
asymmetry information thatcharacterizethe economic
activity (Anokhin and Schulze 2008).In addition,corrup-
tion, inefficiency of governments and a weak rule of law as
well as otherweaknessesin the country infrastructure,
increase transaction and agency costs,thuslimiting the
income of the firms (Manzettiand Wilson 2007) and,in
consequence,increase the opportunistic behavior of firms.
By contrast, control of corruption, a strong rule of law and an
effectiveness of government (a high index value) increase
the chance of entrepreneurs capturing a larger portion of the
revenues that they generate by increasing the reliability of
cash flows (Rose-Ackerman 2001) and, consequently, they
reduce the opportunistic behavior in firms. Furthermore, in
recent years Latin American countries have made reforms to
theirlegalframeworks,modifying laws and establishing
harsherpunishments forthose persons who demonstrate
corruption practices. Based on the above, we formulate the
following hypothesis in the sense that a negative association
between the government index and EM could be expected.
H9 A country with higher levels of governability shows a
lower level on earnings management practices.
Design and Research Methodology
Sample and Data
Our sample comprises firms listed on main Latin American
stock markets,specifically,in the markets ofArgentina,
Brazil,Chile,and Mexico,during the period 2006–2009.
We selectthese countries for their relevance in the Latin
AmericaEconomyand discardColombiadue to the
insufficient number of available observations.The sample
is obtained from companies listed on the Mexican Stock
Exchange (Bolsa Mexicana de Valores),Santiago Stock
Exchange (Bolsa de Comercio de Santiago), Stock Market
of Buenos Aires (Mercado de Valores de Buenos Aires),
and the Sao Paulo Stock Exchange (Bolsa de Valores de
Sao Paulo) during the period 2006–2009.Financialinsti-
tutions are excluded,as is common in this type of studies
becauseof their particularaccountingpractices.The
accounting data on financial statements was obtained from
Economatica database,while data on CG and ownership
structure come directly from annualreports submitted by
companies to the different regulatory agencies,3 which are
available on their websites.We obtained information for
435 firms and a total of 1,740 observations for the period
from 2006 to 2009. The composition of the sample allows
the combination oftime seriesand crosssectionswith
adequate opportunity to take advantage of the creation of
paneldata,especially in the controlof unobserved heter-
ogeneity,i.e.,the individualcharacteristics of each entity
that are not observable but affect the variables under stud
(Arellano and Bover1991;Arellano 1993;Himmelberg
et al. 1999;Palia 2001;Brick etal. 2005).Additionally,
since atpresentthe idea of using unbalanced panels with
totalobservations is widely accepted,the option ofana-
lyzing balanced panels with fewer companies is discarded
because it may be conditioned by the survival bias (Baltag
and Chang 1994).
Measurement of Abnormal Accruals
We define earnings managementin terms of ‘absence of
manipulative practices’.This is because the intentional
manipulation of earnings by managers may reduce the us
fulness of earnings to the overall users (Velury and Jenkins
2006; Matis et al. 2010). Earnings that are persistence and
predictable may not be of high quality if this results from
earnings management (Dechow and Schrand 2004). We u
the modified version of Jones (1991) proposed by Dechow
et al.(1995) which has been used in other studies such as
Teoh etal. (1998) and Xie etal. (2003) to determine the
discretional accruals.Following Dechow et al.(1995),we
compute the accrual component of earnings as:
Total Accrualsit ¼ ðDCAit DCash itÞ ðDCLit
DSTD itÞ Depit ð1Þ
where DCAit = change in totalcurrentassets;DCashit =
change in cash and cash equivalents;DCLit = change in
total current liabilities; DSTDit = change in long-term debt
included in currentliabilities;Depit = depreciation and
amortization expenses.We use the cross-sectional version
of the modified Jones (1991) modelto estimate the non-
discretionary component of total accruals (TAC) (DeFond
and Jiambalvo 1991; Yeo et al.2002).
TACit
Ai;t1
¼ b0 þ b1
DREVit
Ai;t1
þ b2
PPEit
Ai;t1
þ eit ð2Þ
For each yearand industry we regress totalaccruals
(TAC) on the change in revenues (DREV) and the level of
grossproperty,plantand equipment(PPE), scaled by
lagged totalassets (At-1 ) in orderto avoid problems of
heteroskedasticity.Using the estimates for the regression
parameters,(^b0;^b 1;^b2),we estimate each sample firm’s
non-discretionaryaccruals(NDCA) by adjustingthe
changein sales for the changein accountsreceivable
(DAR) to allow forthe possibility thatfirms could have
manipulated sales by changing credit terms (Dechow et al
1995).
3 For Mexico,Brazil,Chile, and Argentina the annualreports are
availableat www.bmv.com.mx;www.bmfbovespa.com.br;www.
bolsadesantiago.com; www.cnv.gov.ar.
Does Corporate Governance Influence Earnings Management in Latin American Markets? 425
123

NDCAit ¼ ^b0 þ ^b1
DREVit DAR it
Ai;t1
þ ^b2
PPEit
Ai;t1
ð3Þ
And we define discretionary accruals (DCAit) for firm
i in year t as the remaining portion of Total accruals:
DACit ¼TACit
Ai;t1
NDCA it ð4Þ
Thus, we use the absolutevalue of discretionary
accruals [Abs(DCA)it] as a measure of the degree of EM.
This is consistentwith previousstudieson earnings
management which point out that the study of the quality
of results does notimpose any direction orsign on the
expectations of EM (Wartfield et al. 1995; Gabrielsen et al.
2002; Wang 2006; Chen et al.2007; Barth et al.2008).
Models and Variables Definition
Since the aim is to investigatethe influencethatCG
mechanismshave on EM, measuredby discretionary
accruals,we regressthe absolute value ofdiscretionary
accruals[Abs(DCA)it] on the variablesof ownership
structure,Board of Directors and control used in previous
literature,according to the following model:
Abs DACð Þit ¼ b0 þ b1 Int OWNð Þ þ b2 OWN Conð Þ
þ b3 Fam OWNð Þ þ b4 Inst OWNð Þ
þ b5 Board SIZEð Þ þ b6 Board INDð Þ
þ b7 Board ACTð Þ þ b8 CEO Dualð Þ
þ b9 GOV Indexð Þ þ b10 Controlð Þ þ gi
þ kt þ tit
The unobserved heterogeneity is controlled in the two
models through individual effects of companies (gi). Also,
we included dummy variablesto controlthe temporal
effects (kit) and the error term (tit). As a proxy for internal
property (Int_OWN) we use the proportion of shares C1 %
owned by members of Board of Directors and managers of
the firms;the ownership concentration (OWN_Con)is
measured by the proportion of shares owned by the major
shareholder of the company,because many firms in Latin
America are directly controlled by one of the industrial or
financialconglomerates thatoperate in the region (Lopez
and Saona 2005; Cespedes et al.2008); family ownership
(Fam_OWN) is measured by the proportion of shares held
by family members,i.e.,the percentage of capitalthatis
directly or indirectly in their hands C5 % and; institutional
ownership (Inst_OWN)through the proportion ofshares
held by institutional investors. Board size (Board_SIZE) is
measured by the total number of directors that integrate the
Board of Directors;Board independence (Board_IND) is
measured by the proportion of external directors inside the
Board (external directors/total directors) and with a dummy
variable (Board_IND50) that takes the value of one when
the Board comprises a majority of external directors; Boar
activity(Board_ACT)is measuredby the numberof
meetingsheld during theyear;President–CEO duality
(CEO_Dual) is measured through a dummy variable that
considers the value of 1 if there is duality of roles between
the chairman and CEO ofthe firm and,0 otherwise.
Finally, there is the government Index (Gov_Index), which
measures the governability level of the country (control of
corruption,rule of law and government effectiveness).
We also control the effect of various factors through the
inclusion of variables which have been used in previous
studies and have been associated with EM and CG.Thus,
we includethe variablequality and reputation ofthe
externalauditor(Big_4)measured by a dummy variable
that takes the value 1 if the company is audited by one of
the big four auditfirms,0 otherwise.Several studies thus
indicate thatquality ofaccounting information willbe
linked to the prestige and quality of the externalauditor
(Lennox 1999; Jara and Lo´pez 2007),because more repu-
table auditors limit the possibility of EM and therefore, the
financialstatements audited by these firms have greater
credibility (DeFond and Subramanyam 1998;Teoh etal.
1998).
Anothercontrolvariableis firm size (Log_ASSET)
measured by the natural logarithm of total assets at the e
of year (Sanchez and Sierra 2001),controlling with it the
effectsof company size on accounting choice.Authors
generally expect,and often prove,a negativerelation
between firm size and EM, given that larger companies are
expectedto have more sophisticatedcontrolsystems,
skilled advisers,more negotiating power with the external
auditor and are subjectto increased monitoring by inves-
tors and analysts, so accounting fraud is less probable tha
in smaller firms,where the managers of these companies
have more opportunitiesto manipulate the information
(Goodwin and Kent2006;Prior et al. 2008).We also
include the indebtedness levelvariable (Debt),calculated
as the ratio oftotaldebtand totalassets.Thus,a high
indebtednessis associatedwith the risk of excessive
leverage (Press and Weintrop 1990),which motivates the
EM to concealinconvenientinformation and display a
greater capacity to generate resources (Dechow et al. 199
Krishnan et al.1996; Balsam et al.2003).
Additionally,following Francis and Wang (2004)we
include two controlvariables on firm performance.The
first is the growth variable (GROWTH), measured in terms
of the relation of the difference in sales and sales of the
previous period for firm iin year t,which indicates that
companies with high growth rates are more likely to use
discretionary accruals (McNichols 2000). The second is the
variable (ROA),calculated by the ratio between earnings
before extraordinaire,interestand taxes of year tand the
426 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

total net assets at beginning of year t, and positively related
to the use ofdiscretionary accruals.This suggeststhat
managers are motivated to manipulate the results upward,
i.e., increase the profitsobtained with the intention of
making the company more attractive (Kothari et al.2005;
Machuga and Teitel 2007).
Also, because a poor financial situation of the company
could increase agency costs and encourage the manage-
mentto manipulate the accounting numbers (Nurulet al.
2010) we include the control variable loss (Loss) which is
measured through a dummy variable that takes value of 1 if
the company hashad lossesin the last2 yearsand,0
otherwise.Finally,we consider the sector of activity vari-
ables (IND) and year (YEAR), which are important factors
of measurementbecause sectors and specific years could
have a better results by identifying discretionary accruals
(Roychowdhury 2006).
Analysis and Results
Descriptive Analysis
Table 1 displays the descriptive statistics and tvalues of
discretionary accruals for estimated [Abs(DCA)it], showing
that mean values of discretionary accruals are, in all cases,
statistically different from zero.This does not allow us to
reject the null hypothesis and, therefore, provides evidence
thatLatin American companies manipulate theirresults,
either by increasing profits to denote a better and higher
profitability of the company or,on the contrary,reducing
them asfiscal strategyaims to pay fewer taxesand
contributions.
Table 2 shows the mean, median, standard deviation and
the associated tvalue of the estimated coefficients of the
absolute value of discretionary accruals [Abs(DCA)it] per
country. It can be seen that the model significantly explains
variations in the coefficients of discretionary accruals, as its
explanatory power shows Adjusted R2 values (significance
level) above 40 % for all the countries.
Table 3 shows the main descriptive statistics of quan-
titative and dichotomous variables.Thus,with respect the
Board characteristics variables itcan be seen thatin the
four countriesanalyzed,generally,companiesBoards
meets on average 5 times a year.It can also be seen that
Boards are composed of a mean of 11 members, of whom
38.5 % are externaldirectors,a factthatclearly indicates
thatthe composition ofthis organ ofgovernmentis a
majority of internalmembers,thus demonstrating control
and dominion among thosethathavefamilieson this
governing body.
Regardingownershipstructure,Table 3 showsthat
Mexican companies have highest family engagement, with
37.1 %, followed by Argentinian (35 %), Chilean (26.2 %),
and Brazilian (24 %) companies.The ownership concen-
tration (major shareholder) reflects an average of 29.4 % o
the socialcapitalof firms.Hence,Chilean companies are
those that revealed have a higher shareholding concentra
tion with 32.2 %, followed by Brazilian (29.3 %), Mexican
(28.6 %),and Argentinean(27.5 %)firms. Moreover,
regarding the internal ownership (top management),it can
be seen that manager and directors holds, on average, 6.1
of the social capital of companies. Thus, Brazilian firms are
those thatrevealed have a higher internal ownership with
7.3 %,followed by Argentinean (7.1 %),Chilean (6 %),
and Mexican (4.5 %) companies.Finally,the institutional
ownership indicates an average value of 22.8 % of social
capitalheld by institutionalinvestors.Thus, Brazilian
companies are those that have revealed a higher participa
tion of institutional investors with 23.9 %, followed by the
Chilean (23.8 %),Argentinean(21 %), and Mexican
(20.6 %) firms.
Regression Results
After analyzing the variables descriptively,it is necessary
to apply tests to help measure the linear relation between
the dependentvariable ‘‘absolute value ofdiscretionary
accruals [Abs(DCA)it]’’ and the independentand control
variablesof the firms.The explanatory developmentis
based mainly on determining the level of influence that CG
mechanismshas on discretionary accruals.In order to
determine which model is best suited to our data, (the fixe
Table 1 Descriptive statistics of discretionary accruals [Abs(DCA)it]
estimations by year
Years N Mean Median SD T Adjusted
R2
DAC-2006 435 0.224 0.119 0.441 0.619 0.536
DAC-2007 435 0.278 0.112 0.704 -1.070 0.285
DAC-2008 435 0.198 0.122 0.293 1.567 0.118
DAC-2009 435 0.249 0.142 0.420 -0.243 0.808
Global 1,740 0.237 0.121 0.489 1.459 0.447
Table 2 Descriptive statistics of discretionary accruals [Abs(DCA)it]
estimations by country
Country N Mean Median SD T Adjusted R2
Argentina 308 0.247 0.137 0.425 0.412 0.744
Brazil 480 0.293 0.152 0.481 1.749 0.476
Chile 532 0.236 0.101 0.651 1.852 0.542
Mexico 420 0.167 0.110 0.198 1.493 0.408
Global 1,740 0.237 0.121 0.489 1.459 0.447
Does Corporate Governance Influence Earnings Management in Latin American Markets? 427
123

Table 3 Descriptive statistics of quantitative and dichotomous variables observations by country
Variable Statistics Argentina Brazil Chile Mexico Global
N 308 480 532 420 1,740
Quantitative variables
Int_OWN Mean 0.071 0.073 0.060 0.045 0.061
Std.Dev. 0.046 0.048 0.047 0.038 0.046
OWN_Con Mean 0.275 0.293 0.322 0.286 0.294
Std.Dev. 0.106 0.102 0.118 0.101 0.107
Fam_OWN Mean 0.350 0.240 0.262 0.371 0.305
Std.Dev. 0.163 0.177 0.181 0.181 0.179
Inst_OWN Mean 0.210 0.239 0.238 0.206 0.228
Std.Dev. 0.145 0.136 0.135 0.135 0.137
Board_SIZE Mean 11.49 11.38 11.54 11.47 11.47
Std.Dev. 3.82 3.69 3.60 3.66 3.67
Board_IND Mean 0.400 0.394 0.366 0.375 0.385
Std.Dev. 0.730 0.891 0.077 0.862 0.083
Board_ACT Mean 5.42 5.37 5.33 5.15 5.31
Std.Dev. 2.49 2.50 2.47 2.38 2.46
GOV_Index Mean 41.13 51.12 88.05 48.78 49.73
Std.Dev. 3.25 2.51 0.68 2.06 18.78
Log_ASSET Mean 13.32 13.39 18.39 16.09 15.58
Std.Dev. 1.91 1.75 2.32 1.70 2.93
Debt Mean 0.396 0.504 0.280 0.227 0.350
Std.Dev. 1.371 0.691 0.924 0.158 0.862
ROA Mean 4.47 4.58 9.18 6.96 6.56
Std.Dev. 1.84 1.67 2.36 1.70 2.79
GROWTH Mean 0.236 0.531 0.103 0.124 0.249
Std.Dev. 0.617 2.221 0.299 0.484 1.241
Dichotomous variables
Board_IND50 0 148 (48.1 %) 240 (50.0 %) 316 (59.4 %) 224 (53.3 %) 928 (53.3 %)
1 160 (51.9 %) 240 (50.0 %) 216 (40.6 %) 196 (46.7 %) 812 (46.7 %)
CEO_Dual 0 99 (32.1 %) 193 (40.2 %) 209 (39.3 %) 172 (40.9 %) 673 (38.7 %)
1 209 (67.9 %) 287 (59.8 %) 323 (60.7 %) 248 (59.1 %) 1,067 (61.3 %)
Big_4 0 144 (46.8 %) 199 (41.5 %) 180 (33.8 %) 120 (28.6 %) 643 (36.9 %)
1 164 (53.2 %) 281 (58.5 %) 352 (66.2 %) 300 (71.4 %) 1,097 (63.1 %)
Loss 0 234 (76.0 %) 373 (77.7 %) 436 (81.9 %) 319 (75.9 %) 1,362 (78.3 %)
1 74 (24.0 %) 107 (22.3 %) 96 (18.1 %) 101 (24.1 %) 378 (21.7 %)
Quantitative variables: Int_OWN Internal ownership, measured by the proportion of shares owned by managers and members of B
OWN_Con Ownership Concentration, measured by the ratio of shares held by the major shareholder of the company (C5 %); Fam_
Ownership, measured by the proportion of shares held by family members (C5 %), as a percentage of capital that is directly or ind
possession; Inst_OWN Institutional Ownership, measured by the proportion of shares held by institutional investors; Board_SIZE Si
of directors,measured by the totalnumber of members of Boards;Board_IND independence of the Board,measured by the proportion of
independent members (independent directors/total directors); Board_ACT Activity of Boards, measured by the number of meeting
The degree of law enforcement of each country analyzed, taken from the research project ‘‘Worldwide Governance Indicators’’ (W
by Kaufmann etal. (2010);Log_ASSET Firm size,measured by the naturallogarithm oftotalassets ofthe companies;DebtLevel of
indebtedness, measured by the quotient resulting from gross debt to total assets; ROA Economic Return, measured by the ratio of
between the result before special items, interest and taxes of year t and the total net assets at the beginning of year t; GROWTH G
Companies,calculated in terms of the ratio of the difference in sales and sales of the previous period of firm i in year t
Dichotomous variables: Boad_IND50 Measured through a dummy variable that takes value of 1 if boards has a majority of indepen
and, 0 otherwise; CEO_Dual Measured through a dummy variable that considers the value of 1 if there is duality of roles between
and CEO of the companies and, 0 otherwise; Big_4 Measured by a dummy variable that takes the value 1 if the firms are audited b
four firms, 0 otherwise; Loss Measured through a dummy variable that takes value of 1 if the companies have had losses in the las
otherwise
428 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

effects based on groups estimator or random effects based
on generalizedleast squares(GLS)), we perform the
Hausman test(1978),which determines whether the dif-
ferences are systematic and significantbetween the two
models.In all cases,the resultof this testdoes notreject
the nullhypothesis of no systematic differences between
the regressors’and unobserved heterogeneity,therefore
assuming the random effects as the mostappropriate for
our analysis.
Thus, in Table 4 the model 10 shows the results obtained
from the linear regression of the paneldata,the absolute
value of discretionary accruals [Abs(DCA)it] on the vari-
ables of ownership structure, Board of Directors and control.
With regard to the internal ownership, is observed that the
stake held by managers and directors in Latin American
firms have a significant negative relation at level of 1 % with
the absolute value of discretionary accruals.The findings
show a significantnegative relation atlevelof 1 % with
ownership concentration and board size (5 %).
In addition, the model 10 shows that Board activity has a
negative relation,significant at level of 5 %,showing that
the greaternumberof meetingsheld by the Boards
decreases the use of discretionary accruals. We do not find
any statistically significantrelation between family own-
ership (Fam_OWN),institutionalownership (Inst_OWN),
CEO duality (CEO_Dual),and the absolute value of dis-
cretional accruals.
On the other hand, there is a significant negative relation
at the 1 % level between Government Index (GOV_Index)
and discretionary accruals.Finally,in the remaining con-
trol variables it can be seen that they maintain their level of
significance and the expected sign:there is a significant
negative relation atthe 5 % levelbetween firm size and
discretionary accruals and a significant positive relation at
the 1 % level between discretionary accruals and levelof
debt,economic profitability and growth.
Additionally, in model 11 of Table 4 we use a different
proxy for Board independence, replacing the proportion of
externaldirectors on Boards (Board_IND)by a dummy
variable that takes the value of 1 if Board has a majority of
externaldirectors,and 0 otherwise (Board_IND50).The
conclusionsare the same asmodel10, i.e., the Board
independence also shows a weak negative relation signifi-
cant at the 10 % level with the dependentvariable
[Abs(DCA)it].
Analysis Extension
Non-linear Relations
In this section we extend the previous analyzes to test the
possible nonlinear relations between CG mechanisms and
EM. As we have shown in the literature review section,
thereare competing viewsaboutthe effectof certain
governance characteristics on earnings management. Thu
we have re-tested model 10,including the quadratic terms
for insider ownership,ownership concentration and board
activity.With these analyses we willtry to explain ifa
U-shape relation could explain the ambiguousoutcome
regarding these variables.
Thus,since previous studies have found non-linearities
which supportboth the convergence-of-interests and the
entrenchmenthypotheses in differentownership intervals
(Morck etal. 1988;Yeo et al. 2002),we examine the
possiblenon-linearitiesin the relation between insider
ownership and discretionary accruals.In Table 5,model
(12),we testthe non lineareffectof insiderownership
(Int_OWN and Int_OWN2) on earnings management along
with the other governance and control variables.Similarly
in models (13)and (14)we check the non-linearities of
ownership concentration (OWN_Con and OWN_Con2)
and board activity (Board_ACT and Board_ACT2).
In model(15) we reportthe results when we take into
account the non-linearities in the three variables (Int_OWN
OWN_Con, Board_ACT). This model shows that the linear
and quadratic terms of the internal ownership are significa
at the 1 and 5 % levels,respectively,with the linear term
negative and the quadratic term positive,suggesting that
when the ownership of the insiders increases it reduces th
EM by managers (Weisbach 1988; Fernandez 1998; Corne
et al.2008),but,as we can observe in Table 6,when the
internal ownership reaches a certain point,4 which is around
14.1 %, the situation is reversed with an increase in manip
ulative practices by insiders.
Additionally,Table 5 shows thatfor the concentration
of shares held by major shareholders,the linear and qua-
dratic term are significantat the 1 and 5 % levels,
respectively,with the linearterm negative and the qua-
dratic positive,indicating thatownership concentration is
also a mechanism thatcould restrictthe manipulative
practiceswhen the proportion ofsharesheld by major
shareholdersis not very high (efficientmonitoring
hypothesis). Table 7 shows the non-linear relation in detai
indicating thatwhen ownership concentration reachesa
certain point,5 which is located around 35.1 %, there is an
increase in the use of discretionary accruals.
4 This minimum is calculatedby differentiatingthe dependent
variable with respect to the internal ownership and equating to zero,
and q/qx = 0,thus obtaining the value ofinternalownership that
verifies this condition and proving that2y q/qx [ 0,which implies
that this point is a minimum.
5 This minimum is calculatedby differentiatingthe dependent
variable with respectto the ownership concentration and equating
to zero,and q/qx = 0,thus obtaining the value ofthe ownership
concentration that verifies this condition and proving that 2y q/qx [ 0
which implies that this point is a minimum.
Does Corporate Governance Influence Earnings Management in Latin American Markets? 429
123

Table 4 Discretionary accrual regressions on corporate governance and control variables,random effects estimation (GLS)
Variable Expected
sign
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Int_OWN – -0.433** -0.481*** -0.491***
(-1.84) (-2.01) (-2.05)
OWN_Con – -2.340** -2.174*** -2.354***
(-1.56) (-1.36) (-1.52)
Fam_OWN ? -0.089 -0.055 -0.079
(-0.91) (-0.55) (-0.80)
Inst_OWN – -0.073 -0.080 -0.083
(-0.92) (-1.00) (-1.04)
Board_SIZE ? 0.032* 0.053** 0.035**
(0.73) (1.19) (0.80)
Board_IND – -3.201* -3.513*
(-1.67) (-1.79)
Board_IND50 – -0.024* -0.027*
(-1.10) (-1.22)
Board_ACT – -0.097* -0.127** -0.114*
(-1.61) (-2.07) (-1.87)
CEO_Dual ? 0.009 0.005 0.007
(0.41) (0.21) (0.29)
GOV_Index – -0.167*** -0.169*** -0.174*** -0.173*** -0.173*** -0.171*** -0.178*** -0.173*** -0.174*** -0.156*** -0.163***
(-3.51) (-3.54) (-3.66) (-3.65) (-3.65) (-3.60) (-3.73) (-3.65) (-3.67) (-3.27) (-3.41)
Big_4 – -0.027 -0.027 -0.028 -0.028 -0.027 -0.026 -0.027 -0.029 -0.027 -0.029 -0.029
(-1.18) (-1.20) (-1.23) (-1.23) (-1.19) (-1.15) (-1.17) (-1.27) (-1.17) (-1.26) (-1.28)
Log_ASSET – -0.030** -0.032** -0.030** -0.028** -0.028** -0.022** -0.031** -0.033** -0.029** -0.024** -0.035**
(-1.75) (-1.87) (-1.80) (-1.65) (-1.66) (-1.24) (-1.82) (-1.93) (-1.75) (-1.37) (-2.05)
Debt ? 0.314*** 0.315*** 0.314*** 0.314*** 0.316*** 0.317*** 0.315*** 0.315*** 0.315*** 0.316*** 0.314***
(2.37) (2.38) (2.37) (2.37) (2.38) (2.39) (2.38) (2.38) (2.38) (2.37) (2.36)
ROA ? 0.045*** 0.045*** 0.047*** 0.044*** 0.046*** 0.043** 0.047*** 0.047*** 0.046*** 0.043*** 0.047***
(2.58) (2.62) (2.71) (2.54) (2.65) (2.49) (2.72) (2.71) (2.65) (2.45) (2.70)
GROWTH ? 0.031*** 0.031*** 0.031*** 0.031*** 0.031*** 0.031*** 0.031*** 0.030*** 0.031*** 0.029*** 0.029***
(3.49) (3.48) (3.48) (3.52) (3.49) (3.50) (3.50) (3.43) (3.50) (3.27) (3.28)
Loss ? 0.001 0.003 0.005 0.005 0.005 0.005 0.005 0.008 0.004 0.006 0.006
(0.04) (0.10) (0.19) (0.19) (0.18) (0.18) (0.19) (0.29) (0.13) (0.22) (0.20)
Significance 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000 0.000
430 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

Finally,concerning the Boards activity,in Table 5 the
full model shows that the linear term has a weak negative
significance atlevelof 10 % and the quadratic term is
positive butnotsignificant,providing an explanation for
the contradictory effect of Board activity.
Robustness Analysis
In order to verify the robustness between models,Table 8
shows the comparison of the results exposed in previous
section with other models also used in literature to measu
the quality of results, like the original version of the Jones
model (1991), the Jones cash flow model used by Jeter and
Shivakumar (1999) and,the KS model proposed by Kang
and Sivaramakrishnan (1995). Thus, it is observed that the
originalJones model,the Jones cash flow modeland the
KS model showsqualitatively similarresultsto those
obtained through the Modified Jonesmodel,so demon-
strating the robustness of the tests.
Discussion
Our study has analyzed the effects of CG over the earning
management, measured by discretionary accruals, for a se
of non-financial companies listed on Latin American stock
markets,specifically,listed companiesin marketsof
Argentina,Brazil,Chile,and Mexico.
In relation to the participation of the management team
on firms’ ownership, our results show a non-linear relation
between insiders ownership and discretionary accruals tha
suggeststhatinternalownership isa mechanism that,
despite differences in CG systems,may restrict the use of
discretionary accruals only when the proportion of shares
owned by the insiders is not very high. Our result is in line
with those obtained by Machuga and Teitel (2009) with a
sample of Mexican firms,who show thatfirms with less
internalownership show a greaterearnings quality com-
pared to those that do not have managerial ownership, i.e
shows less manipulative practices by managers, because
the implementation ofgood CG practicescontained in
Codes of BestPractices.Likewise,other studies such as
Morck et al. (1988) in Canada, Wartfield et al. (1995) in th
US, Yeo etal. (2002) in Singapore and Sanchez-Ballesta
and Garcia-Meca (2007) in Spain,also pointoutthatthe
informativeness ofaccounting results increases with low
levels of internalownership,while for a high levels,the
internalownership isnot sufficientas a mechanism of
interest alignment.
Regarding the influence of ownership concentration, the
results confirm hypothesis H2 and suggestthatwhen the
main shareholders have a high percentage of ownership o
when a conglomeratedirectlycontrolsthe firm, the
Table 4 continued
Variable Expected
sign
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11)
Adjusted R2 0.2729 0.2726 0.2719 0.2719 0.2717 0.2727 0.2720 0.2726 0.2716 0.2777 0.2770
Number of observations 1,740 1,740 1,740 1,740 1,740 1,740 1,740 1,740 1,740 1,740 1,740
Model 10: Abs(ADD)it = b0 ? b 1(Int_OWN) ? b2(OW-
it = b0 ? b 1(Int_OWN) ? b2(OWN_Con) ? b3(Fam_OWN) ? b4(Inst_OWN) ? b5(Board_SIZE) ? b6(Board_IND) ? b7(Board_ACT) ? b8(CEO_Dual) ? b9(Big_4) ? b10(Log_ASSET) ?
b11(Debt) ? b12(ROA) ? b 13(GROWTH) ? b14(Loss) ? b15(GOV_Index) ? gi ?k t ? t it
Notes.The model includes industry sectors and time controls,but they are not reported.Z statistics in parentheses
Quantitative variables: Int_OWN Internal ownership, measured by the proportion of shares owned by managers and members of Boards (C1 %); OWN_Con Ownership Concentration, measured
held by the major shareholder of the company (C5 %); Fam_OWN Family Ownership, measured by the proportion of shares held by family members (C5 %), as a percentage of capital that is di
possession;Inst_OWN Institutional Ownership,measured by the proportion of shares held by institutionalinvestors; Board_SIZE Size of boards of directors,measured by the total number of members of Boards;
Board_IND independence of the Board, measured by the proportion of independent members (independent directors/total directors); Board_ACT Activity of Boards, measured by the number of
Firm size, measured by the natural logarithm of total assets of the companies; Debt Level of indebtedness, measured by the quotient resulting from gross debt to total assets; ROA Economic R
of the relation between the result before special items, interest and taxes of year t and the total net assets at the beginning of year t; GROWTH Growth of the Companies, calculated in terms o
sales and sales of the previous period of firm i in year t; GOV_Index The degree of law enforcement of each country analyzed, taken from the research project ‘‘Worldwide Governance Indicato
Kaufmann et al.(2010)
Dichotomous variables: Boad_IND50 Measured through a dummy variable that takes value of 1 if boards has a majority of independent directors and, 0 otherwise; CEO_Dual Measured through
considers the value of 1 if there is duality of roles between the chairman and CEO of the companies and, 0 otherwise; Big_4 Measured by a dummy variable that takes the value 1 if the firms a
four firms,0 otherwise; Loss Measured through a dummy variable that takes value of 1 if the companies have had losses in the last 2 years and,0 otherwise
*** Significant at level 1 %; ** significant at level 5 %; * significant at level 10 %
Does Corporate Governance Influence Earnings Management in Latin American Markets? 431
123

Table 5 Non-linear relation in internal ownership,ownership concentration and board activity
Variables (12) (13) (14) (15)
Int_OWN -0.978*** -0.456** -0.486** -0.873***
(-1.06) (-1.90) (-2.03) (0.94)
Int_OWN2 2.888** 2.401**
(0.55) (0.46)
OWN_Con -2.150** -2.101*** -2.099** -2.126***
(-1.35) (-1.17) (-1.32) (-1.47)
OWN_Con2 1.749** 1.540**
(1.46) (1.54)
Fam_OWN -0.057 -0.063 -0.056 -0.068
(-0.58) (-0.64) (-0.56) (-0.68)
Inst_OWN -0.079 -0.076 -0.078 -0.074
(-0.99) (-0.95) (-0.98) (-0.92)
Board_SIZE 0.053* 0.051* 0.047* 0.044*
(1.20) (1.15) (1.06) (0.99)
Board_IND -3.556* -3.190* -3.534* -3.231*
(-1.81) (-1.62) (-1.80) (-1.64)
Board_ACT -0.124* - 0.134* -0.191* -0.134*
(-2.03) (-2.18) (-0.94) (-0.55)
Board_ACT2 0.094 0.231
(0.39) (1.13)
CEO_Dual 0.004 0.005 0.006 0.007
(0.20) (0.23) (0.27) (0.31)
GOV_Index -0.156*** -0.160*** -0.154*** -0.159***
(-3.28) (-3.35) (-3.23) (-3.32)
Big_4 -0.027 -0.027 -0.029 -0.027
(-1.20) (-1.21) (-1.27) (-1.17)
Log_ASSET -0.025** -0.026** -0.024** -0.028**
(-1.38) (-1.47) (-1.37) (-1.49)
Debt 0.317*** 0.316*** 0.316*** 0.315***
(2.37) (2.37) (-2.36) (2.34)
ROA 0.043** 0.044*** 0.044** 0.046***
(2.47) (2.52) (2.49) (2.60)
GROWTH 0.029*** 0.029*** 0.028*** 0.028***
(3.26) (3.25) (3.23) (3.21)
Loss 0.006 0.008 0.008 0.009
(0.21) (0.28) (0.27) (0.33)
Significance 0.000 0.000 0.000 0.000
Adjusted R2 0.2772 0.2786 0.2781 0.2792
Number of
Observations
1,740 1,740 1,740 1,740
Model 15: Abs(ADD)it = b0 ? b 1(Int_OWN) ? b2(Int_OWN2) ? b3(OWN_Con) ? b4(OWN_Con2) ? b5(Fam_OWN) ? b6(Inst_OWN) ? b7(Board_SIZE) ? b8(Board_
IND) ? b 9(Board_ACT) ? b10(Board_ACT2) ? b11(CEO_Dual) ? b12(Big_4) ? b13(Log_ASSET) ? b14(Debt) ? b15(ROA) ? b 16(GROWTH) ? -
? bBoardACT ? b 1BoardACT ? b11CEODual ? b 1Big ? b 1LogASSET ? b 1Debt ? b1ROA ? b 1GROWTH ? b 1Loss ? b 1GOV
Index ? gi ? k t ? t it
*** Significant at level 1 %,** significant at level 5 %,* significant at level 10 %
Notes.The model includes industry sectors and time controls,but they are not reported.Z statistics in parentheses
Quantitative variables:Int_OWN Internalownership,measured by the proportion of shares owned by managers and members of Boards ( C1 %);OWN_Con Ownership
Concentration, measured by the ratio of shares held by the major shareholder of the company ( C5 %); Fam_OWN Family Ownership, measured by the propo
by family members (C5 %), as a percentage of capital that is directly or indirectly in his possession; Inst_OWN Institutional Ownership, measured by the prop
held by institutional investors; Board_SIZE Size of boards of directors, measured by the total number of members of Boards; Board_IND independence of the
by the proportion of independent members (independent directors/total directors); Board_ACT Activity of Boards, measured by the number of meetings; Log
measured by the naturallogarithm of totalassets of the companies;DebtLevelof indebtedness,measured by the quotientresulting from gross debtto totalassets,ROA
Economic Return, measured by the ratio of the relation between the result before special items, interest and taxes of year t and the total net assets at the b
GROWTH Growth of the Companies, calculated in terms of the ratio of the difference in sales and sales of the previous period of firm i in year t; GOV_Index T
enforcement of each country analyzed,taken from the research project ‘‘Worldwide Governance Indicators’’ (WGI) proposed by Kaufmann et al.(2010)
Dichotomous variables: Boad_IND50 Measured through a dummy variable that takes value of 1 if boards has a majority of independent directors and, 0 othe
Measured through a dummy variable that considers the value of 1 if there is duality of roles between the chairman and CEO of the companies and, 0 otherw
by a dummy variable that takes the value 1 if the firms are audited by one of the big four firms, 0 otherwise; Loss Measured through a dummy variable that
companies have had losses in the last 2 years and,0 otherwise
432 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

absolute value of discretionary accruals is reduced,due to
the efficientmonitoring hypothesis indicated by Agency
theory (Jensen and Meckling 1976; Fama 1980; Fama and
Jensen 1983).The findings are also consistentwith Fer-
nandez etal. (1998),Yeo etal. (2002),Gabrielsen etal.
(2002),and De Bosand Donker(2004),who note the
monitoring role of external block holders, and their strong
positive effects on earnings informativeness. However, the
findingsnote that ownershipconcentrationis also a
mechanism thatcould restrictthe manipulative practices
when the proportion of shares held by major shareholders
is notvery high (efficientmonitoring hypothesis).Above
35.1 % concentration,an increase in the use ofdiscre-
tionary accruals is observed, confirming that environments
with high ownership concentration promote the EM.
Therefore,our resultsconfirm thatinsiderownership
and ownership concentration are mechanisms that, in spite
of the differences in corporate governance,may constrain
discretionary accruals when the proportion of shares held
by insiders or block holders is not too high.Nevertheless,
when insidersand large shareholdersown a large per-
centage of outstanding shares,they tend to make discre-
tionary accounting choices.
Our results confirm hypothesis 5 and revealhow the
dimension of Boards creates problems of communication
and coordination that decreases the monitoring of the ma
agement team,thus increasing the EM.Also,our findings
show that board independence has a weak negative relati
significant only at the 10 %, so we reject hypothesis 6. Ou
result contrasts with the prominent role that both the theo
retical and empirical literature has assigned to this attribu
of the Board to safeguard the quality and transparency of
results but,for the case of Latin American countries ana-
lyzed, it does not seem to be so effective.
In this regard,Price et al. (2006,2007),Teitel and
Machuga (2008),Chong etal. (2009),and Davila and
Watkins (2009) in Mexico; Silveira et al.(2003),Schiehll
and Santos(2004),and Ferraz etal. (2011)in Brazil;
Iglesias(1999)in Chile; suggestthat this is due to
Boards’being mainly composed ofmajorshareholders
and managers ofthe companies,with externaldirectors
having a very limited participation,which facilitates the
EM and the managerialdiscretion.It is probable that this
evidence is derived,as stated by Yermack (2004),from
the presence ofgrey directors,lack of rotation ofthe
directors or both.
Grey directorsare those thatmaintain some kind of
family or professional relationship (present or past) with th
company or its top management. The fact that in the annu
reports of CG they are designated as external and almost
no way disclose any possible conflicts ofinterestcould
severely limit the Board independence. As regards the sec
ond,its slow or almostnon-existentrotation makes them
permanently external, and thus the report of the First Lati
American Corporate Governance Survey,conducted by
Price Waterhouse Cooper(PWC) in 2010 (published in
2011) indicates that on average only 12.35 % of companie
listed on Latin American stock markets put time limits for
externaldirectors.In short,according to Monterrey and
Sanchez (2008), both groups might fall into the category t
Eguidazu (1999) calls ‘‘the label’’, in which independence
an appearance and not an attitude,because the absence of
sufficientdistance from the managementof the company
could, in fact, concentrate power inside the Board, thereby
facilitating EM (Garcı´a Osma and Gill de Albornoz 2007).
Furthermore,concerning Board activity,a higher num-
ber of meetings can mean a greater involvement of Board
in tasks and monitoring activities and their taking a much
more active position to safeguard the quality of financial
information and,hence,reduce the use ofdiscretionary
accruals,which confirms H7.
Finally,we notice a significantnegative relation atthe
1 % levelbetween GovernmentIndex (GOV_Index) and
discretionary accruals (hypothesis 9), suggesting that whe
a country implements controls aimed atreducing corrup-
tion, strengtheningthe rule of law or improvingthe
Table 6 Discretionary accruals by ranks of internal ownership
Rank (%) [Abs(DCA)it]a Rank (%) [Abs(DCA)it]a
0.0–1.0 0.7283 10.1–11.0 0.1744
1.1–2.0 0.5128 11.1–12.0 0.1696
2.1–3.0 0.3766 12.1–13.0 0.1669
3.1–4.0 0.3302 13.1–14.0 0.1471
4.1–5.0 0.3183 14,1–15.0 0.1879
5.1–6.0 0.2580 15.1–16.0 0.2008
6.1–7.0 0.2251 16.1–17.0 0.2108
7.1–8.0 0.2184 17.1–18.0 0.2370
8.1–9.0 0.2126 18.1–19.0 0.2374
9.1–10.0 0.1975 19.1–20.0 0.2390
a Absolute value of discretionary accruals estimated from the Jones
Modified Model
Table 7 Discretionary accruals by ranks of ownership concentration
Rank (%) [Abs(DCA)it]a Rank (%) [Abs(DCA)it]a
10.0–15.0 0.2208 35.1–40.0 0.2213
15.1–20.0 0.2200 40.1–45.0 0.2378
20.1–25.0 0.2143 45.1–50.0 0.2572
25.1–30.0 0.2067 50.1–55.0 0.2827
30.1–35.0 0.1967 55.1–60.0 0.3303
a Absolute value of discretionary accruals estimated from the Jones
Modified Model
Does Corporate Governance Influence Earnings Management in Latin American Markets? 433
123

Table 8 Comparison of models of discretionary accruals robustness test
Variables Jones Modified Jones Original Jones Cash Flow KS
Int_OWN -0.481*** -0.451** -0.486** -0.472**
(-2.01) (-2.25) (-2.14) (-2.33)
OWN_Con -2.174*** -2.374* -1.353* -1.883*
(-1.36) (-1.82) (-0.89) (-1.39)
Fam_OWN -0.055 -0.035 -0.069 -0.036
(-0.55) (-0.54) (-0.73) (-0.43)
Inst_OWN -0.080 -0.043 -0.052 -0.029
(-1.00) (-0.62) (-0.69) (-0.43)
Board_SIZE 0.053** 0.073* 0.041* 0.055*
(1.19) (1.91) (0.99) (1.47)
Board_IND -3.513* -2.628* -2.419* -2.420*
(-1.79) (-1.47) (-1.30) (-1.46)
Board_ACT -0.127** -0.025** - 0.141** -0.027*
(-2.07) (-0.38) (-2.42) (-0.53)
CEO_Dual 0.005 0.005 0.005 0.007
(0.21) (0.34) (0.25) (0.38)
GOV_Index -0.156*** -0.066* -0.138*** -0.086*
(-3.27) (-2.13) (-3.04) (-2.12)
Big_4 -0.029 -0.016 -0.025 -0.015
(-1.26) (-0.69) (-1.16) (-0.78)
Log_ASSET -0.024** -0.022* -0.037** -0.031**
(-1.37) (-1.33) (-2.19) (-2.05)
Debt 0.316*** 0.315** 0.266*** 0.270***
(2.37) (2.59) (2.10) (2.39)
ROA 0.043** 0.037** 0.052*** 0.044***
(2.45) (2.21) (3.14) (2.99)
GROWTH 0.029*** 0.025*** 0.019** 0.014*
(3.27) (3.29) (2.24) (1.88)
Loss 0.006 0.012 0.011 0.005
(0.22) (0.49) (0.42) (0.19)
Significance 0.000 0.000 0.000 0.000
Adjusted R2 0.2777 0.2255 0.2306 0.2687
Number of Observations 1,740 1,740 1,740 1,740
Notes.The model includes industry sectors and time controls,but they are not reported.Z statistics in parentheses
Quantitative variables: Int_OWN Internal ownership, measured by the proportion of shares owned by managers and members of B
OWN_Con Ownership Concentration, measured by the ratio of shares held by the major shareholder of the company (C5 %); Fam_
Ownership, measured by the proportion of shares held by family members (C5 %), as a percentage of capital that is directly or ind
possession; Inst_OWN Institutional Ownership, measured by the proportion of shares held by institutional investors; Board_SIZE Si
of directors,measured by the totalnumber of members of Boards;Board_IND independence of the Board,measured by the proportion of
independent members (independent directors/total directors); Board_ACT Activity of Boards, measured by the number of meeting
Firm size,measured by the natural logarithm of total assets of the companies; Debt Level of indebtedness,measured by the quotient resulting
from gross debt to total assets, ROA Economic Return, measured by the ratio of the relation between the result before special item
taxes of year t and the total net assets at the beginning of year t; GROWTH Growth of the Companies,calculated in terms of the ratio of the
difference in sales and sales of the previous period of firm i in year t; GOV_Index The degree of law enforcement of each country a
from the research project ‘‘Worldwide Governance Indicators’’ (WGI) proposed by Kaufmann et al.(2010)
Dichotomous variables: Boad_IND50 Measured through a dummy variable that takes value of 1 if boards has a majority of indepen
and, 0 otherwise; CEO_Dual Measured through a dummy variable that considers the value of 1 if there is duality of roles between
and CEO of the companies and, 0 otherwise; Big_4 Measured by a dummy variable that takes the value 1 if the firms are audited b
four firms, 0 otherwise; Loss Measured through a dummy variable that takes value of 1 if the companies have had losses in the las
otherwise
*** Significant at level 1 %,** significant at level 5 %,* significant at level 10 %
434 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

effectiveness of government,this seems to influence EM
negatively,i.e., it shows an increase in the quality and
transparency of the financialinformation issued by com-
panies, thus showing a reduction of discretionary accruals.
The results are in line with those noted by Labelle etal.
(2010),who pointto a higherlevelof corporate moral
development being associated with higher quality financial
reporting.
Our research contributes to the debate by demonstrating
that, in Latin America, with a corporate governance system
characterized by low investor protection and high ownership
concentration, insider ownership and ownership concentra-
tion affect discretionary accruals. The findings demonstrate
that on average earnings are more likely to be manipulated
when insider ownership and ownership concentration is too
high.Both results are consistentwith insiders and large
shareholders possessing information acquisition and infor-
mation processing advantages.This study also has policy
implicationsby showing thatcorruption,inefficiency of
governments and a weak rule of law increase opportunistic
behavior in Latin American firms.Our findings also have
important policy implications since they support the opinion
that the full application of the Anglo-Saxon corporate gov-
ernance model is inappropriate (Sanchez-Ballesta and Gar-
cia-Meca 2007)and they contribute to the literature by
extending the research into the effects of corporate gover-
nance on portfolio firm’s earnings management.
Our research design is subject to several limitations. The
mostobviousconcern isthe measurementproblemsof
earnings management.Nevertheless,the differentmodels
used in the paper(Jones original,Jones modified,Jones
cash flow,and KS model)indicate thatthe resultsare
robust after controlling for alternative measures of discre-
tionary accounting accruals.Because our results focus on
four Latin Americancountriesand on one period,
2006–2009,both country and time period are other limi-
tations of the study. Further research might examine if the
relations found in this study can be extended to other Latin
Americancountriesand periods.This could provide
increased robustness of the results. A further refinement of
the variables used (e.g.,if in the future regulators forced
companies to disclose whetherthe independentdirectors
have any conflict of interest that would alter the degree of
Board independence), or the simple fact of having data that
it is currently difficult to know,such as the nationality of
institutional investors, could lead to a better understanding
of the relation between internal mechanism of CG and EM
in Latin American markets.Despite these limitations,this
study addsto the ethicsliteratureby considering the
ownership structure and board of directors and extends the
line of research on earnings managementand corporate
governance.
Concluding Remarks
Being aware of the existence of opportunistic EM activities
evokes a general interest in factors that may constrain the
actions.The main objective was to analyze the relation
between the internal mechanisms of CG and EM in firms
listed on the main Latin American stock markets,specifi-
cally in the markets of Argentina,Brazil,Chile and Mex-
ico,during the period 2006–2009.The findings offer new
insights into these relations in an institutional context that
greatly differs from those ofthe countries considered in
previous literature (particularly the US system).
The findings show that the environment of high ownersh
concentration thatexistsin Latin American companies
negatively affects the quality and transparency of financia
information thatis issued to the market,suggesting that
ownership concentration may be a constrictor mechanism
manipulative practices only when the ownership of the ma
shareholders is moderate. Similarly, internal ownership is
mechanism that,despite differences in CG systems,could
restrict the practices of discretionary accruals only when t
proportion of shares owned by insiders is not very high.
In contrastto the Anglo-Saxon context,the relation
found between the level of earnings manipulation and the
proportion of independent directors is weak,probably due
to the presence of grey directors and the lack of rotation o
directors in Latin American firms.
Furthermore, our results show that when a country impl
ments controls aimed atbehaving ethically,reducing cor-
ruption,strengthenthe rule of law or improvingthe
effectivenessof government,these seem to increase the
quality and transparency of the financial information issue
firms, so improving ethical behavior of their managers and
consequently, showing a reduction of discretionary accrua
As a result, this paper tries to provide valuable input for re
ulators who are requesting continuous analyticalwork to
know the implications of exceptionally poor governance an
suggests that policy makers should consider the character
of firms as well as the institutional environment before the
implement additional corporate governance reforms.
AcknowledgmentsThis study is part of research project ECO2011-
29144-C03-02,supported by the Ministry ofEconomic and Com-
petitiveness of Spain.
Open Access This article isdistributed underthe termsof the
Creative Commons Attribution License which permits any use,dis-
tribution,and reproduction in any medium,provided the original
author(s) and the source are credited.
Appendix
See Table 9.
Does Corporate Governance Influence Earnings Management in Latin American Markets? 435
123

Table 9 Correlation matrix
Variables Abs(DAC)it Int_OWN OWN_Con Fam_OWN Inst_OWN Board_SIZE Board_IND Board_ACT
Abs(DAC)it 1.000
Int_OWN -0.069*** 1.000
OWN_Con -0.065*** 0.105*** 1.000
Fam_OWN -0.046* 0.030 -0.092*** 1.000
Inst_OWN -0.042 -0.015 -0.014 0.076*** 1.000
Board_SIZE 0.061** 0.083*** 0.200*** -0.015 -0.015 1.000
Board_IND -0.068*** 0.029 0.193*** 0.144*** -0.020 0.199*** 1.000
Board_ACT -0.070*** -0.106*** 0.087*** -0.025 -0.019 0.149*** 0.299*** 1.000
CEO_Dual 0.003 -0.045 0.001 0.026 0.009 0.022 0.077*** 0.044
Big_4 -0.004 -0.018 -0.039 -0.047** 0.040 -0.044 -0.049** 0.002
Log_ASSET -0.101*** -0.083*** -0.345*** -0.093*** 0.005 -0.355*** -0.377*** -0.350***
Debt 0.507*** 0.043 0.043 -0.056** 0.036 0.136*** 0.172*** 0.064***
ROA 0.090*** 0.086*** 0.338*** 0.111*** 0.016 -0.443*** -0.442*** -0.331***
GROWTH 0.058** 0.020 0.041 -0.030 -0.011 -0.001 0.033 0.061**
Loss 0.115*** 0.030 0.048** 0.019 0.037 0.090*** 0.152*** 0.148***
GOV_Index -0.123*** -0.087*** -0.102*** -0.030 0.017 0.047* 0.039 0.070***
Variables CEO_Dual Big_4 Log_ASSET Debt ROA GROWTH Loss WGI
Abs(DAC)it
Int_OWN
OWN_Con
Fam_OWN
Inst_OWN
Board_SIZE
Board_IND
Board_ACT
CEO_Dual 1.000
Big_4 0.057** 1.000
Log_ASSET -0.059** 0.113*** 1.000
Debt 0.020 0.050** -0.164*** 1.000
ROA -0.065*** 0.118*** 0.274*** -0.120*** 1.000
GROWTH -0.022 -0.022 -0.059** -0.021 -0.050** 1.000
Loss 0.078*** -0.036 -0.226*** 0.213*** -0.218*** -0.057** 1.000
GOV_Index 0.043* 0.001 -0.084*** 0.119*** -0.073*** -0.033 0.157*** 1.000
Quantitative variables:Abs (DAC)it Absolute value of discretionary accruals estimated from the Modified Jones Model;Int_OWN Internal
ownership,measured by the proportion of shares owned by managers and members of Boards (C1 %); OWN_Con Ownership Concen
measured by the ratio of shares held by major shareholder of the company (C5 %); Fam_OWN Family Ownership, measured by the
shares held by family members (C5 %),as a percentage ofcapitalthatis directly or indirectly in his possession;Inst_OWN Institutional
Ownership, measured by the proportion of shares held by institutional investors; Board_SIZE Size of boards of directors, measured
number of members of Boards;Board_IND independence of the Board,measured by the proportion of independentmembers (independent
directors/total directors); Board_ACT Activity of Boards, measured by the number of meetings; Log_ASSET Firm size, measured by
logarithm of total assets of the companies; Debt Level of indebtedness, measured by the quotient resulting from gross debt to tot
Economic Return, measured by the ratio of the relation between the result before special items, interest and taxes of year t and th
at the beginning of year t; GROWTH Growth of the Companies, calculated in terms of the ratio of the difference in sales and sales
period of firm i in year t; GOV_Index The degree of law enforcement of each country analyzed,taken from the research project ‘‘Worldwide
Governance Indicators’’ (WGI) proposed by Kaufmann et al.(2010)
Dichotomous variables: Boad_IND50 Measured through a dummy variable that takes value of 1 if boards has a majority of indepen
and, 0 otherwise; CEO_Dual Measured through a dummy variable that considers the value of 1 if there is duality of roles between
and CEO of the companies and, 0 otherwise; Big_4 Measured by a dummy variable that takes the value 1 if the firms are audited b
four firms, 0 otherwise; Loss Measured through a dummy variable that takes value of 1 if the companies have had losses in the las
otherwise
*** Significant at level p B 0.01,** significant at level p B 0.05,* significant at level p B 0.10
436 J. Sa´enz Gonza´lez,E. Garcı´a-Meca
123

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