Three Essays on Earnings Quality

This thesis aims to investigate earnings quality, by employing recent methodologies. The thesis has three empirical chapters. The first empirical chapter is about the profile of chief executive officers (CEO) and earnings quality. Based on previous studies, I introduce a measure of CEO profile, denoted PSCORE, which aggregates nine personal characteristics of CEOs. Data for the construction of the PSCORE are publicly available on the CEOs’ curriculum vitae and firms’ financial statements. Following previous studies, I measure earnings quality in different ways: abnormal accruals (Jones, 1991; Dechow, Sloan, and Sweeney, 1995; Peasnell, Pope, and Young, 2000b); abnormal cash flows, abnormal production costs, and abnormal discretionary expenditures (Roychowdhury, 2006); and deviations of the first digits of figures reported in financial statements from what are expected by Benford’s Law (Amiram, Bozanic, and Rouen, 2015). Using a sample of UK listed companies for 2005-2012, I find positive relationships between the PSCORE and all proxies for earnings quality. Also, the evidence shows that the relationships are stronger when CEOs’ equity-based compensation incentives are higher. The findings suggest that the PSCORE can be useful to signal a red flag of poor earnings quality. The study has some implications for practitioners. The second empirical chapter examines the role of banking expertise on the board of directors on accounting conservatism. Using the working histories in banks of individual directors on the board, I measure banking expertise on the board by accumulating the numbers of years and the numbers of banks individual directors have worked for. Using a sample of UK listed companies for 2005-2012, I show that the measures of banking expertise on the board are negatively associated with firm-year accounting conservatism. Additional analyses indicate that the relationships between accounting conservatism and banking expertise on the board are more pronounced for firms which face high bankruptcy risk and have high financial leverage. A possible explanation is that directors with banking expertise provide the board with information about the market-level demand for accounting conservatism and they also bring interpersonal networks in the banking industry that can act as a private communication channel in debt contracting, leading to a reduction in accounting conservatism which is documented in recent studies as costly for borrowing firms. The study makes a significant contribution to the existing literature, especially in that it offers an innovative way to measure banking expertise on the board and it complements the work of Erkens, Subramanyam, and Zhang (2014) and Bonetti, Ipino, and Parbonetti (2017) by providing further evidence on the relevance of boards of directors for accounting conservatism. The last empirical chapter is about applying Benford’s Law to study the earnings quality of UK listed companies. I employ Benford’s Law, which is the law of digit distributions, to examine the first digits of financial statement items of UK listed companies. I find that the first digits of figures reported in financial statements of UK companies for 2005-2012 follow Benford’s Law at the firm-specific level and market level. Next, the evidence suggests income statements may contain more errors (as evidenced by higher deviations of first digits from what are expected by Benford’s Law) than those of balance sheets and cash flows statements. Also, I find that earnings management and accounting conservatism are two explanations for first-digit deviations. While previous studies support the positive relationship between earnings management and first-digit deviations, the study is the first which provides an alternative explanation for first-digit deviations from Benford’s Law. I suggest that a plausible explanation is that accounting conservatism introduces biases to financial statements, which make accounting figures deviate from the law of digit distributions. The results have implications for auditors