Does corporate governance affect the relationship
between earnings management and ﬁrm performance?
An endogenous switching regression model
Published online: 1 January 2014
Ó Springer Science+Business Media New York 2013
Abstract This study investigates whether corporate governance affects the relationship
between earnings management and ﬁrm performance by using Taiwanese data. We used an
endogenous switching regression model to classify ﬁrms into strong and weak governance
regimes based on an endogenously determined threshold. The results show that discre-
tionary accruals (DAs) and discretionary current accruals (DCAs) have signiﬁcantly
negative effects on return on assets and Tobin’s q for ﬁrms in a weak governance regime.
This implies that managers in weakly governed ﬁrms are more likely to abuse accounting
discretion than those in strongly governed ﬁrms, leading to decreased ﬁrm performance.
Managers prefer using DCAs rather than DAs to window-dress ﬁnancial earnings, but this
causes a greater reversal of corporate value in the subsequent period. Conversely, DAs and
DCAs are positively and signiﬁcantly related to ﬁrm performance in a strong governance
regime. This indicates that managers under strong governance typically exercise optimal
accounting choices to respond to varied economic conditions, or to avoid costly debt-
covenant violations, potentially enhancing ﬁrm value.
Keywords Corporate governance Á Earnings management Á Firm performance Á
Endogenous switching regression model Á Discretionary current accruals
JEL Classiﬁcation G30 Á G32 Á G34 Á G38 Á M41
H.-W. Tang (&)
Department of Insurance, Tamkang University, 151, Yingzhuan Rd., Tamsui Dist.,
New Taipei City 25137, Taiwan, ROC
Department of Finance, Asia University, 500, Lioufeng Rd., Taichung City 41354, Taiwan, ROC
Rev Quant Finan Acc (2015) 45:33–58