Co-opted boards and earnings management: Evidence of reduced short-termist behavior

Abstract

This study contributes to the emerging literature on board co-option by examining how and to what extent co-opted directors influence managers’ attitudes about earnings management. We find robust evidence that co-option mitigates both real activities and accrual-based earnings management. Our findings support the view that higher co-option reduces managerial short-termism because it enhances managers’ job security as co-opted directors are known to be less likely to remove managers from office. Our results are robust to different measures of both co-option and earnings management, and they continue to hold after accounting for endogeneity and selection concerns. Finally, we provide additional evidence showing that a higher degree of co-option lowers the likelihood of the chief executive officer (CEO) being forcefully removed from the office for managing earnings in the previous year. JEL CLASSIFICATION G30; G34; G39