RMET6053 - Impact of Governance & Auditing on Earning Management

This report investigates the impact of corporate governance and external auditing on earning management, addressing concerns raised by corporate scandals and the need to protect stakeholder interests. It identifies the elements of corporate governance and external auditing, examines their impact on earning management, and proposes strategies for effective management of earnings. The research uses a positivism philosophy and applied research approach, employing quasi-experimentation to validate existing theories. It covers a literature review, methodology including research design, philosophy, approaches, data collection and analysis methods, sampling, research validity, reliability, and ethical considerations.

Running head: RESEARCH METHODS
Research Methods
Name of the student
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Executive Summary
The corporate companies have been under strict surveillance so that the stakeholder’s
interest can be protected. This is mainly in the context of regulations and rules in the
corporate industry. The business world has been stunned by the various scandals in the late
90s and the early start of 20 century. This report has proposed a research on the topic of
impact of corporate governance and external auditing on earning management. The
methodology and literature review has been developed and following the given methodology
is expected to provide positive result.

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Table of Contents
Introduction................................................................................................................................3
Aims and Objective....................................................................................................................4
Literature Review.......................................................................................................................5
Methodology..............................................................................................................................9
References................................................................................................................................13

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Topic: Impact of Corporate governance and external auditing on earning management
Introduction
The corporate companies have been under strict surveillance so that the stakeholder’s
interest can be protected. This is mainly in the context of regulations and rules in the
corporate industry. The business world has been stunned by the various scandals in the late
90s and the early start of 20 century. The big companies that were involved in such scandals
were WorldCom, HealthSouth and Enron (Agrawal and Cooper 2017). These major scandals
have affected the financials and management of different corporate organisations all over the
world. Globalization has enabled free trade in the market, so investment in developing
countries and developed countries have increased significantly. The importance of financial
reporting has increased significantly due to the increase in the number of investors and the
amount of investment made in the market.
Therefore, in order to protect the interest of stakeholders in different countries
external auditing and corporate governance have been emphasised. The stock exchanges and
financial governing bodies have instructed managing activities and monitoring the unhealthy
practices in the organisation (Aguilera et al. 2015). Empirical studies on financial reporting
and corporate governance have thrown light on the fact that earning management can be used
by the different firm to paint a picture that is favourable. Earning management can be used to
mask the real image and provide vague information to the stakeholders.
Therefore, accountant and regulators all over the world have been worried about this
grey area of accounting which increases the risk factor for the organisations in the corporate
industry. Researches in accounting show that low earnings reporting is associated with low
content of the financial reporting which implies manipulation from the management
(Agrawal and Cooper 2017). The stakeholders have been demanding effective reporting of

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the financial data so that the true equity value will be reflected. Stakeholders consider this
information to be the benchmark for extrapolating returns in the future.
Aims and Objective
This study will identify the impact of corporate governance and external auditing on
earning management. The different components of corporate governance and external
auditing will be identified in this research along with the elements of earning management.
The impact of the components of corporate governance and external auditing on the elements
of earning management will be examined. The research will not take any particular
organization or country and the generalized impact of corporate governance and external
auditing will be analysed. The study will identify the gap in literature in different researches
to address those issues that still needs to be addressed.
The objective of this research are as follows:
 To identify the different elements of corporate governance
 To evaluate the different elements of external auditing
 To investigate the impact of corporate governance and external auditing on earning
management
 To recommend suitable strategies for effective management of earning
Research question
 What are the different elements of corporate governance?
 What are the different elements of external auditing?
 What are the impacts of corporate governance and external auditing on earning
management?

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Research hypothesis
H0: There is no impacts of corporate governance and external auditing on earning
management
H1: There is impacts of corporate governance and external auditing on earning management
Literature Review
This part of the study will critically evaluate the three factors which are corporate
governance, external auditing and earnings management. As stated by Miko and Kamardin
(2015), corporate governance covers a wide perspective that explains the traditions, ethics,
policies, sequential steps and bodies that will used to control, supervise and direct the
companies. Corporate governance is based on values and ethics which is used for governing
and taking follow ups within the organization. According to Iraya, Mwangi and Muchoki
(2015), corporate governance is aimed at maximizing the capacity of gaining more profit
within the organization which means profit maximization or maximization of the stakeholder
value.
As opined by Katmon and Al Farooque (2017), the objective of corporate governance
is providing opportunity to the management in effectively dealing with the risk factors so that
the organization can be treaded to long term success. However, the basic problem that is
faced by the government is conflict in interest between the organizational stakeholders and
the managers. In context to the agency, it can be exclaimed that corporate governance has a
positive effect on mitigating the issues faced by the government. The different elements of
corporate governance are board size, board activities and ownership structure. The
foundation of corporate management is laid out by effectively implementing corporate
governance within the organization.

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As stated by Lin, Hutchinson and Percy (2015), external auditing is a mode of
reducing the level of risk faced by the investors. External auditing facilities in reducing the
information asymmetry and protecting the interest of the different stakeholders by reducing
the chances of material mismanagement. The stakeholders rely on the external auditors for
providing them with assurance that the financial statements are not misleading so that they
can accurate calculate the potential equity in the future. Therefore, the role of audit
committee is very crucial in providing support to the stakeholders by developing effective
financial reporting.
According to the Iraya, Mwangi and Muchoki (2015), the manipulation of the
financial statement of the organization in order to portray a false financial report is known as
earnings management. This is basically done to deceive the partners and the stakeholders
within a firm. Therefore, the activity of developing false number to deceive the stakeholders
is known as earnings management. This activities lead to fraud and can be considered as a
crime. Jizi et al. (2014) states that earnings management means disclosure management
where financial report is purposefully intervened for private gains. Therefore, external
auditing and corporate governance is very important in stopping such activities within the
organization. Moreover, the financial reporting in different countries is different due to the
different standards they use. Therefore, corporate governance is essential for proper
monitoring of the financial activities within the organization. There is significant impact of
external auditing and corporate governance on earnings management which is discussed in
upcoming sections.
Agrawal and Cooper (2017) stated that opportunistic earnings management practice
indicates less reliable accounting earnings which do not indicate performance of companies.
These researchers also stated that the stock market regulators along with investor protection
agencies are concerned regarding earnings management. Aguilera et at (2015) indicated that

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this is particularly after decline of numerous large companies in the current years and they
have also responded through improving corporate governance along with independence of
external auditors. These researchers also revealed that one of the important monitoring
systems is corporate governance and its major objective is not just to directly enhance
corporate performance. It is also focused on resolving the agency problem through
associating management interests with the shareholder interests. According to Gaynor et al.
(2016) corporate governance as well as external audit therefore supports investors through
associating the objectives of management with shareholders objectives. This can further
facilitate in improving the reliability of financial information as well as the integrity of
financial reporting process. He, Pittman, Rui and Wu (2017) elaborated that the auditors have
increased responsibility for reliable financial reporting at the time the role of audit committee
is basically ceremonial and the symbolic efforts of committee might result in efficient
management questionnaire. These researchers also indicated that monitoring offered by an
independent as well as high quality external auditor decreased capability of the management
in managing the earnings. Supporting such view, Gaynor et al. (2016) revealed that
supporting corporate governance effectiveness can deal with the monotoring system and
among them corporate governance decreases ability of management to deal with earnings.
Corporate governance codes within the countries are observed to go through an
extended process of amendment along with enhancing the form of the current code. It is also
gathered from analysis of the previous literature that the process of earnings management is
associated with corporate governance. This includes attributes including commitment,
composition of nomination as well as remuneration committees and gender diversity. He,
Pittman, Rui and Wu (2017) indicated that earnings management takes place with effect from
external auditing at the time when the managers exercise their discretion over accounting
numbers devoid of restrictions. Such type of discretion might be in the form of firm value

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maximization. Agency theory also indicates that the corporate governance in alignment with
the external auditing improves interest convergence among the shareholders as well as the
managers. Agrawal and Cooper (2017) stated that based on same, earnings management is
deemed to be measured employing the magnitude of discretionary accruals that is anticipated
through performance matched discretionary accruals. These researchers also stated that the
literature on corporate governance and the external auditing offers views regarding evidence
of role of board of directors as internal devices against CEO opportunism. It is also revealed
that the stock based aspects of CEO are related with reserving practices at theme control is
maintained over cross effect among such components and the existence of big four auditors.
In order to decrease the opportunistic behavior certain monitoring mechanism are used by the
independent directors, rating agencies and the external auditors.

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Methodology
The framework within which research is conducted is known as the research
methodology. The methodology section will comprise of the research design, philosophy,
approaches, data collection methods, data analysis methods, sampling, research validity,
reliability and ethical aspect of research (Taylor, Bogdan and DeVault 2015). The
methodology should be appropriate to facilitate in conducting the investigation. The research
methodology is selected based on the nature and purpose of the study. The current research is
objective in view so the study will use quasi-experimentation to validate the existing theories.
The research methodology can be fundamental and applied based on the nature of the study.
In this current study, applied research will be conducted as it addresses real-life issues faced
by the corporate world and the result of the findings will be used to develop a suitable
recommendation that could be used by the corporate organisations mitigate similar issues
faced by them (Lewis 2015).
Research philosophy defines the different methods that should be used for collecting
and analysing data. There are four types of research philosophies, and they are realism,
positivism, interpretivism and pragmatism (Flick 2015). In this current study, positivism has
been selected as the methodology of research as the study aims to use the survey as a method
of data collection. Positivism philosophy is based on observations where observed facts are
developed into meaningful data. The scope of the research in positivism philosophy is
limited to data collection and interpretation. These quantifiable data can be analysed
statistically, but the data is not at all predictable due to the inclusion of human experiences in
the study.
Research approach defines the method of analysing the collected data in the study.
The two different types of research approaches are deductive approach and inductive

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approach. The distinction between the deductive and the inductive method can be made by
the significance of hypothesis in the study (Csikszentmihalyi and Wolfe 2014). The
deductive method is used to prove the theories that have been discussed in the literature
review and the conceptual framework. The inductive approach used for developing new
structures and theories. In this current study, the deductive approach has been selected as the
approach as it will facilitate in improving the observational scope of the study.
Research design has a different meaning to different researches. It can be defined as
the research plan to address the research question in the study. It can also be stated as the
method of choosing between qualitative and quantitative analysis. Research design has been
divided into conclusive and exploratory research (Meyers, L.S., Gamst, G. and Guarino,
A.J., 2016). The explorative research is used to provide a general insight into a situation
while conclusive research offers deep and specific ideas that will facilitate in taking action.
Conclusive research can be further divided into descriptive and causal research. In this
current study, causal research will be used to understand the cause and effect between the
among the research variables.
Data collection is the procedure of gathering information that is relevant to the study
and can be used for providing answers to the research question. There are two types of data
collections, one is primary, and the other is secondary. In this current study, primary data
collection method and consists of a single research design. The primary data collection
method will consist of developing a close-ended questionnaire which will be asked of the
employees of different organisations (Lu and Wang 2017). The study will collect quantitative
data and will analyse the data using statistical techniques. The study will obtain the mean,
mode and median and frequency of responses of the respondents. The research will also use
regression analysis for identifying the relationship between the independent and dependent
variable. Ms Excel is the statistical tool that will be used for analysing the collected data.

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Sampling is the standard for selecting certain members from the population to be a
part of the study. Some populations are huge and difficult to work with, so sampling is a
statistical technique developed to obtain small population from the overall population in the
study. When the population size is enormous, there is no other alternative than to select
element or cases from the population that will represent the overall population. In primary
data collection, there are stages involved in the sampling process such as defining the target
population, determining the size of the sample and selecting the appropriate frame for
sampling. There are two types of sampling methods, one is probabilistic sampling, and
other is non-probabilistic sampling (Palinkas et al. 2015). In this current study, probabilistic
sampling will be used where simple random sampling will be used to select population. The
study will initially collect data from 300 respondents and sampling will be used to reduce the
sample size to 100 respondents. The respondents will consist of accountants and financial
advisors working in different organisations in the United Kingdom.
Reliability is the capability of the research model to replicate the result of the study
using different sets of data. Reliability is a crucial aspect in the study as the success of the
research depends in it. Validity is the degree to which the prescribed methods have been
followed in the study. The study will initially consist of conducting a pilot study where the
questionnaire will be sent to 10 respondent via emails to check whether the desired the
answers can be achieved or not. The questionnaire will be amended based on the results of
the pilot study (Csikszentmihalyi and Larson 2014). The study will also use test rated
reliability where different datasets will be collected to check whether same is obtained or not.
Similarly, content validity will be used to check the appropriateness of the data that has been
collected.
The study will follow the data privacy act so the anonymity of the respondents can
be maintained and their personal data will not be used for any other purpose in the study. The