Bundled Independent Directors and Earnings Management: Fighting for Integrity or Staying Silent

Abstract

Abstract: According to the reputation mechanism theory of independent directors’ performance of duties, independent directors perform their duties diligently in order to maintain their reputation. Independent directors who take office as part of a transfer bundle may play a stronger governance role if they want to maintain the reputation of ‘integrity’, but they may also come across as ‘staying silent’ if they focus on maintaining relationships. This paper takes Chinese A-share listed companies from 2004 to 2019 as a sample to test the impact of bundled independent directors on earnings management. We find that the greater the strength of the independent director’s bundling relationship, the lower the earnings management based on accruals, and the higher the real activity earnings management, which supports the reputation-supervision mechanism. This effect is more significant when the major shareholder has greater power or the firm lacks institutional investor shareholder supervision. The above results indicate that bundled independent directors are likely to have a limited supervisory effect on corporate earnings management, and the ‘staying silent’ strategy can better explain the behavior of bundled independent directors. Further, in non-state-owned enterprises and firms that do not purchase directors’ liability insurance, bundled independent directors have a stronger inhibitory (enhancing) effect on earnings management based on accruals (real activity earnings management). Besides, bundled independent directors have a strong temporal dependence feature, and is more likely to be absent from board meetings, while there is no significant difference in opposing votes compared to other independent directors. This paper makes a useful supplement to the theory of reputation mechanism, enriches the research on the impact of independent directors’ personal characteristics on the performance of their duties, and provides suggestive policies for optimizing the rotation system of independent directors.

Key words: independent director, bundled appointment, earnings management, reputation mechanism

Su Zihao, Peng Fei, Wu Wuqing. Bundled Independent Directors and Earnings Management: Fighting for Integrity or Staying Silent[J]. Management Review, 2025, 37(3): 190-203.

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