Effect Of Corporate Governance On Accounting Conservatism In Manufacturing Companies
Introduction
The increased accounting scandals in the past previous years that caused subside of high reputable companies such as Enron have led several sectors to focus on amending accounting quality and corporate governance (Emmanuel & Salisu, 2018). Corporate governance is the system that is used to manage and control different business operations (Wajeeh & Muneeza, 2012). Due to its collaborative nature, corporate governance efforts are today notable in the business field. Corporate governance has no specific definition (Wajeeh & Muneeza, 2012). Corporate governance is defined as a set of strategies and provisions to minimize agency problems (Jahera & Yost, 2013). Also, it can be interpreted as a shield against economic conditions (Wajeeh & Muneeza, 2012).
Corporate governance for businesses is no longer considered an option (Davies, 1999). Strong governance is necessary to decrease opportunity loss and lower negative net present value projects. It also escalates the transparency of the firm. Good governance must lead managers to expect a reasonable level of risk for the business (Jahera & Yost, 2013).
Corporate governance is necessary to satisfy accounting standards. It doesn’t include all sectors of accounting which arises interest in accounting conservatism. Accounting conservatism is considered an accounting measurement that tends to magnify relative losses or bad news relative to gains or good news (Nasr & Ntim, 2018). Bad news is recognized immediately in the company’s financial statements, while good news isn’t recognized immediately instead, they are recognized over future periods (Nasr & Ntim, 2018) and as a result assist outsiders to efficiently determine their claims (Lafond & Watts,2007).
Accounting conservatism establishes care in financial reporting and accounting under circumstances of uncertainty and complements corporate governance in that it reduces agency problems which allows effective contracting in the presence of asymmetric information (Ahmed & Duellman,2007).
Conservatism has for decades influenced accounting theory and practice and after many comparative researches in 1990, they found conservatism is a tool of performance assurance. (Basu,1997). Moreover, accounting conservatism is an important concept of valuation (Leventis & Dimitropoulos , 2013).
Effective governance systems would allow the application of conservative accounting alternatives. Corporate governance and conservative accounting are closely linked and both are important in reducing contracting agency costs as managers may act on maximizing their own wealth rather than shareholders wealth. (Garcia lara et al, 2009)
Previous studies imply that there are two opposite views on the relationship between corporate governance and accounting conservatism. One point of view, ineffective governance results in high agency conflicts which need higher accounting conservatism so the relation between them is negative (Chi, liu & Wang, 2009). On the other hand, when effective governance is applied management will be supervised better so application of conservative accounting will be favored.
Implementing several Corporate governance mechanisms can be used to monitor managers. These mechanisms are board independence, board size, separation, and managerial ownership structure. One of effective internal CG mechanism is independent directors who play a major role in which they ensure the integrity and credibility of financial statements.
This research paper studies the effect of corporate governance mechanisms on accounting conservatism in manufacturing companies in Egypt by measuring the effect on several Egyptian companies. Egypt was chosen as it is one of the largest economies and it is the largest country in terms of population in the Middle East and North Africa. The study will be applied on manufacturing companies to complement previous studies that where applied on investment banks and stock market. (Nasr & Ntim, 2018).
Literature review
Background Theories
There are some theories that illustrate the relationship between corporate governance mechanisms and accounting conservatism (Ahmed and Duellman, 2007). First, the Agency theory. The agency theory generally refers to a conflict of interest between the management of business and stockholders of the company. The manager who is considered as an agent of stockholders is intended to make decisions that will maximize the shareholders’ wealth although the manager’s interest is to maximize his own (Investopdia. com). Incentives should be given to managers (agents) to motivate them to behave in favor of stockholders (principal). The agency theory has two explanations. The first is that each person behaves in a way to optimize his or her interests against the other person. The second explanation is risk aversion, the risk-taking ability differs from shareholders to managers (Nasr & Natim, 2018). The agency theory indicates that strong corporate governance will need higher conservatism, therefore alleviating the agency problem (Watts, 2003).
Another theory that is dominant in corporate governance is the stewardship theory. Stewardship theory claims that private interests of managers are removed to behave as good stewards of corporate assets; thus, conflicts of interest between management and investors resolve and no agency cost is accrued. First, managers are the ones who will primarily be accused for organizational failure, so they are keen to act in a way that leads to better performance. Next, maximizing shareholders’ wealth is a manager’s main aim. The stewardship theory advocates that there is no dispute between shareholders and managers so there is no need for external supervision (Nasr & Natim, 2018).
Previous research refers to corporate mechanisms that are likely to drive accounting conservatism. This part summarizes the relevant literature that studies the relationship between conservative accounting and board size, board independence, CEO duality and managerial ownership structure.
