Conceptualizing the Effect of Political Instability towards Audit Committee Effectiveness and Earnings Management

Abstract

This paper aims to conceptualize the relationship between audit committee (AC) characteristics and earnings management (EM), hypothesizing that political instability moderates the relationship between the two variables. It seeks to bridge the knowledge gap by proposing a conceptual framework that links AC characteristics, EM, and political instability. The paper reviews recent literature on corporate governance (CG) and EM to understand how AC characteristics may mitigate EM practices. Additionally, it explores the effect of political instability on managers’ engagement in EM. Evidence from prior studies indicates that the AC is a critical component of a firm’s structure, tasked with monitoring the quality of financial information presented in financial reports. An effective AC is argued to play a significant role in reducing EM levels. During periods of intense political instability, managers may be motivated to engage in higher levels of EM to present an enhanced financial performance for their companies. This paper argues that a more effective AC can deter such opportunistic behaviors by managers, thereby limiting their engagement in EM.