Governance effectiveness and earnings quality: Evidence from microfinance institutions

Abstract

Is governance relevant to mitigate earnings management in microfinance institutions (MFIs)? That is the question this article attempts to answer. We study a pooled sample of 345 assessment reports from 2001 to 2011 for 253 MFIs and use two earnings management metrics: a directional accrual-based proxy (income-increasing abnormal loan loss provision) and a non-accrual-based proxy, namely, managing earnings toward a target. We find consistent evidence of the effect of MFI governance effectiveness across the two earnings quality metrics used in the study. Governance effectiveness seems to constrain manager discretion over loan loss provisions in hybrid organizations such as MFIs, that is, institutions with double-bottom-line objectives, and it limits the likelihood that MFIs will report small positive earnings.