| Prior research is inconclusive on the associations between independent directors and earnings conservatism. These studies suffer from deficiencies in research design, including a failure to consider the moderating effects of firm characteristics on the associations. This study reexamines the issue while conditioning the investigation on the extent that investment opportunities (IOS) comprise firm value and addressing research design limitations in prior studies. The analysis employs two measures of earnings conservatism. One is accrual-based advanced by Givoly and Hayn (2000) and Ahmed et al. (2002); the other is based on the differential sensitivity of earnings to negative versus nonnegative returns as developed by Basu (1997). The sample comprises 3,134 (2,516) S&P 500, S&P MidCap 400 and SmallCap 600 public companies from 1997 to 2003 for accrual-based (Basu) measure of conservatism.; The study documents (1) positive associations between both measures of conservatism and the fraction of independent directors on the board and (2) the association between board independence and accrual-based measure of conservatism declines significantly with IOS. Overall, the evidence is consistent with the hypotheses that independent directors encourage conservative accounting, and as IOS and the related information asymmetry between insiders and outsiders increases, the efficacy of independent directors in promoting conservative accounting declines. In addition, the evidence indicates that failure to consider IDS can undermine the ability to detect empirical relationships between board and audit committee independence and earnings conservatism. |
