An analysis of the effect of mandatory adoption of HKAS/HKFRS on earnings management

In this paper, I address two questions related to the introduction of the new accounting standards in Hong Kong in year 2005. The first issue is whether the level of earnings management of companies in Hong Kong is reduced by the mandatory adoption of Hong Kong Accounting Standards (HKAS)/Hong Kong Financial Reporting Standards (HKFRS). The second issue is whether corporate governance variables are more effective in limiting earnings management of companies in Hong Kong after the mandatory adoption of HKAS/HKFRS. Specifically, I explore how corporate governance variables, such as board independence, board size, separation of chairperson and chief executive officer, audit quality, the size and independence of audit committee have impacted earnings quality. My empirical results show that absolute discretionary accruals are higher than those before the adoption of HKAS/HKFRS in year 2005. As a result, earnings quality is impaired and earnings management is increased in the post-HKFRS period. My findings indicate that individual corporate governance variables such as board size and audit quality play an important and effective role in reducing earnings management after the adoption while the impact of other variables in earnings management appear to be weak and insignificant. Findings from this study further reveal that a company’s corporate governance variables, as an aggregate, can improve earnings quality after the mandatory adoption of HKAS/HKFRS. Although the impact of certain corporate governance variables on earnings management is weak on its own, their synergy effects to earnings quality are positive and significant. In practice, it is unlikely that a company would apply only one corporate governance variable to improve earnings quality and therefore, I would like to suggest researchers to further examine the combined effects of corporate governance variables collectively than only focusing on individual variables on earnings management in future.