The Sensitivity of Corporate Governance Systems to

the Timeliness of Accounting Earnings*

Robert Bushman
Kenan-Flagler Business School
University of North Carolina - Chapel Hill

Qi Chen
Fuqua School of Business
Duke University

Ellen Engel**
Abbie Smith
Graduate School of Business
The University of Chicago

July, 2000

*
We have benefited from discussions with and comments from Ray Ball, Sudipta Basu, Bill Beaver, Brian
Bushee, Judy Chevalier, Thomas Hemmer, Bob Kaplan, Scott Keating, Randy Kroszner, Doron Nissim,
Darius Palia, Canice Prendergast, Cathy Schrand, Ross Watts, Jerry Zimmerman and accounting workshop
participants at UC-Berkeley, University of Chicago, Harvard Business School, London Business School,
University of Minnesota, University of Rochester, the 1999 Big Ten Faculty Consortium, 1999 Stanford
Summer Camp and the 1999 Burton Summer Workshop at Columbia. We are grateful to Hewitt Associates
for providing ProxyBase data and to the Graduate School of Business at the University of Chicago for
financial support. Finally, we appreciate the research assistance of Bruce Bower, Xia Chen, Farzad
Farhangnia, Kathleen Fitzgerald, Rebecca Glenn, Karen Kirulis, John Kirulis, Eugene Kovacs, and Harsh
Shroff, and the data assistance of Darin Clay.
**
Corresponding author. 1101 East 58th Street, Chicago. IL 60637, Phone (773)834-0966, Email address:
ellen.engel@gsb.uchicago.edu.
 The Sensitivity of Corporate Governance Systems to
the Timeliness of Accounting Earnings

Abstract
The purpose of this paper is to investigate how governance systems of large public U.S.
corporations vary with information properties of numbers produced by their financial accounting
systems. We argue that in firms whose current accounting numbers do a relatively poor job of
capturing the effects of the firm’s current activities and outcomes on shareholder value, the
accounting numbers are less effective in the governance setting. We predict that such firms will
substitute costly governance mechanisms to compensate for their less useful accounting numbers.
We explore whether governance systems vary with the timeliness of earnings by examining the
cross-sectional relation between proxies for earnings timeliness and subsequent corporate
governance systems of 784 firms in the Fortune 1000. The governance systems we consider
include board composition, stockholdings of inside and outside directors, ownership
concentration and the structure of executive compensation. Our results support a significant
negative relation between our timeliness metrics and subsequent costly corporate governance
mechanisms after controlling for other firm characteristics.

JEL classification: G30, M41, J33

Keywords: Corporate governance, earnings timeliness, properties of earnings

1. Introduction and Motivation

Business activity in the United States is dominated by public firms with dispersed

stockholders in deep, liquid securities markets. The primary governing principle of public

companies in the U.S. is arguably the maximization of shareholder value. The challenge of

promoting shareholder value maximization in a system characterized by dispersed equity

ownership is addressed through a complex portfolio of governance mechanisms, some elements

of which can be tailored to the specific characteristics of the firm.1 The purpose of this paper is to

investigate how governance structures, including the structure of boards of directors, equity

ownership patterns, and executive compensation contracts, of large public U.S. corporations vary

with information properties of numbers produced by their financial accounting systems.

We argue that a firm’s central information system is a key mechanism for addressing

moral hazard problems and that differences in the ability of information systems to mitigate moral

hazard across firms will lead to differential governance mechanism configurations. We view the

financial accounting system as a logical starting point for research into the relation between the

properties of information systems and endogenous formation of governance structures.

Accounting numbers produced under Generally Accepted Accounting Principles (GAAP)

arguably constitute the primary quantitative representation of the firm necessary for the existence

of well functioning capital markets. 2 Financial accounting systems produce extensive, credible

1
The portfolio of governance mechanisms includes those at the firm-level - board of directors structure,
ownership structure and incentive contracts, along market-wide mechanisms involving the legal regime, the
market for corporate control, product market competition, and labor market pressure.
2
Black (2000) argues that there are two essential prerequisites for strong public securities markets. A
country’s laws and related institutions must give minority shareholders: (i) good information about the
value of a company’s business; and (ii) confidence that the company’s insiders won’t cheat investors out of
most of the value of their investment. He contends that institutions necessary for the existence of successful
capital markets include (1) Extensive financial disclosure, including independent audits of public
companies’ financial statements; (2) Accounting rules that address investors’ need for reliable information;
(3) A rule-writing institution with the competence and independence to write good accounting rules and an
incentive to keep the rules up to date; (4) A sophisticated accounting profession with the skill and
experience to catch at least some instances of false or misleading disclosure; (5) Securities or other laws
that impose on accountants enough risk of liability to investors if the accountants have endorsed false or
misleading financial statements so that the accountants will resist their clients’ pressure for more favorable
disclosure.

2
and low cost information that facilitates shareholder monitoring and the effective exercise of

shareholder rights under existing securities laws, enables directors to enhance shareholder value

by advising, ratifying and policing managerial decisions and activities, and provides a basis for

determining the financial rewards from incentive plans designed to align executives’ and

shareholders’ financial interests.

Directors and outside investors who monitor firm and managerial performance need

information to understand changes in equity value. We conjecture that in firms whose current

accounting numbers do a relatively poor job of capturing current value relevant information, the

financial accounting system is less effective in satisfying the governance demands of directors

and shareholders. We predict that such firms will substitute towards alternative, more costly

governance mechanisms to compensate for inadequacies in financial accounting information.

In settings where the usefulness of current accounting numbers is relatively low, we

predict that governance systems are characterized by board structures and powerful equity-based

incentives of inside and outside directors that facilitate costly monitoring activities by the board,

that governance systems are characterized by large shareholdings of individual outside investors

to provide these investors with strong incentives to engage in costly monitoring activities, and

that governance systems are characterized by executive incentive plans that are less dependent on

short-term accounting measures. Our basic premise is a joint hypothesis that 1) the demand for

costly information collection and processing by shareholders and directors is an inverse function

of the usefulness of signals from the accounting system, 2) that an important determinant of the

usefulness of signals from the accounting system is the extent to which they explain current

changes in shareholder value, and 3) specified governance structures characterized by costly

oversight activities are a response to the strength of the demand for costly information collection

and processing by shareholders and directors.

The substitution argument in this paper is consistent with existing evidence that firms

substitute towards non-accounting performance measures in managerial incentive plans in

3
settings where the information provided by financial accounting measures is most limited

(Bushman et al. (1996) and Ittner et al. (1997)). It is also similar in spirit to arguments that capital

market participants will substitute towards costly, private information gathering as the quality of

accounting disclosures deteriorates (e.g., Verrecchia (1982)). Poor accounting representations

may increase the demand for alternative information mechanisms such as private information

collection by financial intermediaries and managers’ voluntary disclosures and/or signaling.

These alternative mechanisms will communicate some of managers’ private information,

contributing a larger “market share” of the total information available to outside directors and

investors of firms whose accounting numbers are least informative.3 However, these alternative

mechanisms will not fully compensate for the limitations of a firms’ GAAP accounting

information, leaving a residual demand for other governance mechanisms to compensate. First,

managers are unlikely to reveal all of their private information about current value creating

activities due to the competitive disadvantages, lack of credibility, and potential legal liabilities

associated with such disclosures.4 Second, information privately collected or signaled is likely to

be available to others only through its impact on stock price. However, the aggregated nature of

this information will limit its value in monitoring the decisions and activities of the managers

(e.g., Paul (1992)).

In related work, LaPorta, Lopez-de-Silanes, Shleifer and Vishny (1998) find that

ownership concentration across countries is inversely related to a measure of the extent of a

country’s accounting disclosures. Also, Ball, Kothari and Robin (2000) posit that international

differences in accounting practices are endogenous functions of the strength of the demand for a

solution to the information asymmetries between managers and other corporate stakeholders.

3
Prior research provides some empirical support for the negative relation between earnings’ market share
of the total information reflected in stock price (as reflected in the correlation between contemporaneous
earnings and stock returns) and both corporate disclosures and analyst activity. See, for example, Lang and
Lundholm (1993) and (1996) and Chen, Engel, and Smith (1999).
4
The accounting literature recognizes the possibility that proprietary costs may lead to incomplete public
disclosure of managers’ private information. See, for example, Verrecchia (1983) and Gigler (1994).

4
They provide evidence that the timeliness of reported earnings is higher in common-law

countries, such as the U.S., where corporate governance structures tend to be associated with

more separation between managers and other stakeholders. While Ball, Kothari and Robin

address the determinants of a country’s accounting regime, we take the U.S. accounting regime as

given, and ask whether cross-firm differences in the ability of the same GAAP to capture current

value relevant information drives real differences in governance configurations.

Our analyses extend existing research on corporate governance systems in two ways.

First, our focus on the properties of a firm’s financial information system as a fundamental

determinant of governance mechanism choices extends existing research on the determinants of

various governance structures. Much of existing research on endogenous choice of governance

mechanisms explores the role of factors relating to the scope or severity of the firm’s moral

hazard problem or the degree of difficulty in monitoring managers (e.g., Demsetz and

Lehn(1985), Smith and Watts (1992) and Himmelberg, et al (1999)).5 The idea in these papers is

that moral hazard and monitoring problems are relatively more severe for firms with high levels

of uncertainty and intangible assets, and where managers have large scope for discretionary

spending. While existing research implicitly treats the properties of firms’ information systems

as unobserved firm effects (Himmelberg, et al. (1999)), we attempt to explicitly capture

differences across firms in the ability of information systems to reflect value enhancing actions

and activities and show that these differences are associated with differences in governance

mechanism choices. Second, in addition to examining the determinants of ownership structure

and management incentives probed in existing research, we also examine factors associated with

5
For example, Demsetz and Lehn (1985) capture uncertainty in the firm’s environment using the standard
deviation of stock returns to examine determinants of ownership concentration, Smith and Watts (1992)
proxy for a firm’s investment opportunity set with market to book ratios in exploring corporate financing,
dividend and compensation policies of firms, and Himmelberg, Hubbard, and Palia (1999) extend Demsetz
and Lehn (1985) by considering the link between management ownership and variables such as R&D,
advertising and tangible asset intensity. Using panel data, Himmelberg, Hubbard, and Palia (1999) also
include fixed firm effects to capture the importance of unobserved (time-invariant) firm effects.

5
the governance mechanisms relating to board of director composition and equity-based incentives

of outside directors.

Our empirical analysis requires metrics that capture meaningful differences in the

usefulness in a governance context of accounting numbers across large public companies in the

U.S. Despite the flexibility and discretion afforded to managers, we contend that the economy-

wide determination of U.S. GAAP imbues financial accounting information with inherent

measurement properties that can be viewed as exogenous at the firm level.6 We focus our

analysis on accounting earnings due to the premier role earnings play in governance and capital

market settings as a summary measure of firm and managerial performance.7 In a governance

setting, the usefulness of earnings is likely to be a function of the information it contains about

the effects of a firm’s current activities and outcomes on shareholder value. To capture this

notion, the information property of earnings we consider is timeliness, defined in Ball, Kothari,

and Robin (2000) as the extent to which current earnings incorporate current economic income or

value-relevant information. We develop several metrics for earnings timeliness based on

traditional and reverse regressions of stock prices and changes in earnings.

We explore whether governance systems vary with earnings timeliness by examining the

cross-sectional relation between our timeliness metrics and proxies for subsequent corporate

governance systems of 784 firms in the Fortune 1000. Our results support a significant relation

between our timeliness metrics and subsequent corporate governance systems after controlling for

other firm characteristics considered in the governance literature. First, we find the predicted

negative relation between the timeliness metrics and our composite variable for board

6
While it is reasonable to assert that financial accounting systems possess inherent measurement properties
beyond the choice of managers, we realize that our empirical proxies may not be capturing only these
inherent properties, which may raise questions of endogeneity. We address the issue of potential
endogeneity in section 6.
7
Our use of aggregate accounting earnings to summarize the information properties of the accounting
system is a pragmatic compromise and not the basis of our argument. In fact, we would argue that the
ability of investors and directors to utilize disaggregated accounting numbers to create a textured portrait of
the firm’s activities is a crucial element in the governance value of financial accounting information. In

6
composition. Our composite variable for board composition aggregates four characteristics of

boards expected to facilitate costly oversight activities. Second, we find the predicted negative

relation between the timeliness of earnings and the stockholdings of inside and outside directors

that provide a direct financial link to shareholders’ interests. We interpret these first two results as

support for the view that in firms whose earnings are of relatively little use in explaining how

current actions and outcomes affect shareholder value, the mix of directors and their equity-based

incentives foster costly oversight activities by the board.

Third, we find the predicted negative relation between the timeliness metrics and the

composite variable for the equity-based incentives of “outside” investors. We interpret this result

as support for the view that the benefits of costly monitoring by large shareholders increase as the

timeliness of earnings declines. Fourth, we find the predicted negative relation between the

timeliness metrics and the composite variable capturing the proportion of the incentive plans

granted to the top five executives which are long-term plans and the proportion which are equity-

based. We interpret this result as consistent with the view that the relative importance of annual

accounting-based bonus plans is reduced in firms whose earnings are untimely.

We also conduct sensitivity analyses addressing issues of potential endogeneity of

earnings timeliness and of the role of regulation. We examine the endogeneity issue by 1)

examining inter and intra-industry relationships between governance structures and earnings

timeliness and 2) using a simultaneous equations framework. Our results are robust with respect

to these sensitivity analyses and those related to the regulatory environment.

The remainder of this paper is organized as follows. Section 2 motivates our focus on the

timeliness of earnings and describes estimation procedures for our timeliness metrics. Section 3

describes our governance variables and develops hypotheses concerning their sensitivity to the

timeliness of accounting numbers. Section 4 describes control variables, sample, and data.

section 2.2, we discuss how we address this and other potential measurement error in the timeliness metrics
explicitly in our empirical design.

7
Section 5 describes our empirical design and results. Sensitivity analyses are presented in Section

6 and section 7 presents a summary and discussion of implications of the paper.

2. Measuring the usefulness of accounting numbers

Our empirical analysis requires that we measure inter-firm differences in the usefulness

of accounting numbers to investors and directors. This section motivates our focus on the

timeliness of earnings and describes the measurement of the relative timeliness of firms’ earnings.

2.1 The timeliness of earnings

We focus our analysis on the timeliness of earnings. Our focus on timeliness is motivated

by several considerations. First, timeliness is likely to be a fundamental determinant of the

usefulness of earnings, and accounting numbers in general, to investors and directors. Second, we

expect the timeliness of earnings to vary considerably across firms in the U.S. Third, the

timeliness of earnings can be readily operationalized. In this section we discuss the specific

definition of timeliness used in our study and the motivation for adopting this definition.

We adopt the specific definition of the timeliness of earnings used in Ball, Kothari, and

Robin (2000) - the extent to which current earnings incorporate current economic income or value

relevant information. We believe this property of earnings is likely to be a fundamental

determinant of the usefulness of accounting numbers in a governance setting. Directors are

responsible for monitoring managerial and firm performance, for advising and ratifying

managerial decisions, and for providing managerial incentives to enhance shareholder value. To

fulfill these responsibilities, directors need information to help them understand how equity value

is changing and why. Outside investors who monitor firm and managerial performance also need

information to understand changes in equity value. Stock prices of public companies provide

information about overall changes in equity value. Accounting systems, by collecting and

8
summarizing the financial effects of firms’ investment, operating, and financing activities, convey

information about the underlying sources of changes in equity value.8

We suggest that the extent to which current accounting numbers capture current changes

in value affects their usefulness to directors and investors. For example, while managers’ current

efforts to develop growth opportunities may substantially increase current equity value, the

increase in equity value is not reflected in accounting numbers until the benefits are realized. The

underlying realization principle undoubtedly produces sales figures that are relatively reliable

measures of historical (i.e. realized) sales. The resulting sales figures, however, do not

incorporate managers’ private information about the effects of managers’ current “strategic”

activities on future sales. The delay with which the accounting system records these benefits may

seriously limit the value of accounting numbers for predicting future cash flows and for providing

timely feedback on managers’ actions.

A second example concerns the lag with which accounting numbers reflect changes in the

value of firms’ assets (or liabilities) in place. Under U.S. GAAP, increases in the value of certain

assets over and above their historical cost are not fully recognized in the accounting system until

the end of the asset lives. In contrast, decreases in asset values below their historical cost are

reflected in the accounting system relatively quickly due to required asset write-downs under

conservative U.S. GAAP. Hence the delayed recognition of holding gains on assets in place also

may limit the value of accounting numbers for predicting future cash flows and for providing

feedback on managers’ decisions and activities.9

A third example arises in settings where the accounting system does not match the timing

of some expenses with their associated revenues. While the ‘matching principle’ of accrual

8
An alternative definition of timeliness used in the accounting literature focuses on the notion of the
frequency of reporting of financial information by firms. Examples of papers focusing on the frequency
aspect of timeliness in a monitoring setting include Leftwich, Watts and Zimmerman (1981), Abreu,
Milgrom and Pearce (1991) and Gigler and Hemmer (1999).
9
See Beaver and Ryan (1993), Basu (1997), and Beaver (1998) for a discussion of the delayed recognition
in earnings of holding gains on assets in place.

9
accounting typically results in the recognition of expenses in the same period as the recognition

of the associated revenues, the matching principle is violated in recognizing expenses associated

with internal investments in “intangible assets” such as brand value, customer loyalty, and

employee expertise. GAAP requires the immediate expensing of expenditures relating to

investments in advertising, R&D, and employee training, presumably due to relatively high costs

of verifying that the future benefits of such expenditures justify their capitalization as an asset.

The associated distortion in earnings as a measure of current firm and managerial performance

may reduce the usefulness of earnings to investors and directors.

The three examples above illustrate how timeliness as defined here (i.e., the extent to

which current accounting numbers capture current changes in equity value) affects the relevance

of accounting numbers to investors and directors.10 The examples also suggest how timeliness

may vary across U.S. firms due to differences in their production functions and their investment

and market opportunities. In the first example, the severity of the delay with which accounting

numbers capture the impact of managers’ actions is likely to increase with the importance of

firms’ growth opportunities and with the length of time required to develop new products,

markets, or technologies. In the second example, the delayed recognition of holding gains on

assets in place may limit the timeliness with which accounting numbers capture changes in equity

value more severely in capital-intensive firms with long asset lives and appreciating asset values.

In the third example, distortions in accounting numbers from mismatching revenues and expenses

may reduce the timeliness of accounting numbers more in firms with large internal investments in

intangibles, especially if such expenditures are not in a “steady state”.11 We expect the inter-firm

10
Note that we are not suggesting that the overall accounting system under GAAP is ineffective. We
acknowledge that GAAP results from standard setters analysis of the trade-off between two primary
characteristics that affect the usefulness of accounting numbers: relevance and reliability. Reliability of
accounting numbers, however, does not imply that accounting numbers are relevant. In fact, the FASB
acknowledges that in establishing its accounting rules, it often sacrifices relevance in return for higher
reliability (FASB (1980), ¶ 90).
11
Barth, Kasznik, McNichols (1998) document evidence that analyst following is higher for firms with
large investments in intangibles. This is consistent with the notion that the demand for alternative sources

10
differences in the timeliness of accounting numbers described above to result in differences in the

timeliness of the summary earnings measures.

A third consideration motivating our focus on the timeliness of earnings is that it can be

readily operationalized. Although the FASB’s definition of timeliness is “generic” and does not

naturally lead to any particular measurement approach, the specific definition we adopt naturally

leads to a measurement approach based on the relation between earnings and contemporaneous

stock returns.

2.2 Metrics of the timeliness of earnings

Our goal is to adopt a metric of earnings timeliness that is designed to measure the extent

to which firms’ current earnings capture all current information pertaining to changes in equity

value. The ideal metrics would involve estimates of equity value that reflect all information,

including any private managerial information. However, because such estimates of equity value

are not available to us, we use firms’ stock prices as estimates of their equity value. Recognizing

that a single metric is unlikely to capture timeliness, we develop three firm-specific metrics of the

relative extent to which firms’ annual earnings capture the total information impounded in stock

price during the year. As discussed later in this section, each of the metrics offers advantages and

disadvantages relative to the others. Our primary timeliness metric is thus an aggregate of the

three-firm-specific metrics.

The first two metrics are based on firm-specific reverse regressions between annual

earnings and contemporaneous stock returns over a period of at least eight years ending in 1994

as follows:12

of information as reflected in analyst following is high among firms with large investments in intangibles
whose accounting numbers are less useful.
12
Our use of a reverse regression between earnings and stock returns follows Beaver, Lambert, and Ryan
(1987), Basu (1997) and Ball, Kothari, and Robin (2000). Allowing the intercept and slope to vary with the
sign of stock returns is patterned after Basu (1997) and Ball, Kothari, and Robin (2000). Ball, Kothari, and
Robin (2000) and Basu (1997) use pooled regressions across firms to examine the differences in the
timeliness of earnings across countries or over time. In contrast, our design requires firm-specific
estimations over time to examine differences in the timeliness of earnings across firms within the US.

11
 EARNt= a0 + a1 NEGt + b1 RETt + b2 NEGt * RETt + et (1)

We compute EARNt as the “core” earnings of a given firm in year t, defined as earnings before

extraordinary items, discontinued operations, and special items, deflated by the beginning of year

market value of equity.13 RET is the 15-month stock return ending 3 months after the end of

fiscal year t. NEG is a dummy variable equal to 1 if RET is negative, and 0 otherwise.14 As

discussed in Basu (1997) and Ball, Kothari, and Robin (2000), the specification in equation (1)

allows b1 to capture the speed with which good news reflected in a firm’s stock returns is

reflected in accounting earnings, while b1+b2 captures the speed with which bad news is reflected

in earnings. This specification is motivated by the higher speed with which earnings are expected

to reflect bad news than good news due to the conservatism of accounting.

Our first metric of the usefulness of earnings is b1, which reflects the relative speed

(across the sample) with which firms’ good news is reflected in firms’ earnings.15 We expect

firms with severe timing problems that delay the recognition within earnings of value-enhancing

activities and outcomes to be identified by low values of b1. Our second metric of the timeliness

of earnings is the R2 from equation (1). As explained in Ball, Kothari, and Robin, (2000), the R2

from equation (1) is a decreasing function of the lag with which earnings capture the news

reflected in stock returns. The R2 also is a decreasing function of the distortions in accruals due,

for example, to the mismatching of revenues and expenses related to investments in intangibles.

13
We focus on core earnings because we expect that they are of greater interest to investors and directors
than bottom line earnings. Prior evidence suggests that stock prices and executives’ bonuses are less
sensitive to special items than to core earnings. Hence, we expect that the demand for governance
structures that facilitate costly monitoring by investors and directors is more sensitive to the timeliness of
core earnings. In addition, there are likely to be relatively high levels of managerial discretion in the timing
of recognizing special items relative to the discretion in the timing of core earnings. To the extent that
managers’ ability and incentives to manipulate bottom line earnings vary with corporate governance
structures, the use of bottom line earnings is likely to lead to a greater violation of our assumption that the
timeliness of earnings is exogenous. Section 6 further discusses and empirically examines the endogeneity
of earnings timeliness.
14
For sample firms that do not have any negative stock returns during the estimation period for model (1)
(i.e. NEG =0 for all observations), we drop NEG and NEG*RET from the specification of equation (1).
15
Although it also might be interesting to consider b2 as a metric, it is not practical to do so because it is not
estimated for a significant number of sample firms that have no negative stock returns during the estimation
period.

12
We expect firms with severe timing problems that delay the recognition within earnings of value-

enhancing activities and outcomes or that distort earnings due to mismatches in revenue and

expense recognition to be identified by low values of R2.

Our third metric of the usefulness of earnings is the R2 from equation (2):

RETt= a0 + b1 EARNt + b2 ∆EARNt + et (2)

where RET and EARN are defined as before, and ∆EARNt is the change in core earnings from

year t-1 to year t, deflated by the market value of equity at the beginning of year t. In contrast to

equation (1), equation (2) allows stock prices to vary with both levels and changes in earnings.

The R2 is interpretable as the “market share” of all value relevant information released during the

year that is captured by the level and change in annual earnings.16 We expect this market share to

be a decreasing function of the lag with which earnings capture changes in equity value. We also

expect this market share to be a decreasing function of the distortions in accruals due, for

example, to the mismatching of revenues and expenses related to investments in intangibles.

The R2 of both models (1) and (2) can be viewed as proxies for the market share of

current value-relevant information represented by current earnings. We refer to the R2 from

equation (1) as REV_R2 to signify that it is based on a reverse regression between earnings and

returns and refer to the R2 from equation (2) as ERC_ R2 to signify that it is based on the more

common returns-earnings regression typically used to estimate earnings response coefficients.

We rely on both equation (1) and equation (2) for our timeliness metrics because they both have

advantages and disadvantages relative to one another. Equation (1) allows the estimation of a

slope that is expected to be an increasing function of the timeliness of earnings. We refer to this

slope (i.e. b1 in equation (1)) as REV_SLOPE to signify that it is from the reverse regression.17

16
In some prior studies, the level of earnings is interpreted as a proxy for the change in book value, so that
the R2 is interpreted as the market share of all value relevant information released during a year captured by
changes in earnings and changes in book value. Our focus on core earnings rather than bottom line earnings
limits our ability to interpret our earnings measure as a measure of the change in book value.
17
In contrast, we do not use the slope from equation (2) because we expect different timing problems to
have opposing effects on the slope from equation (2). For example, we expect the “smoothing” of the

13
Equation (1) also allows for the difference in the speed with which good news and bad news is

reflected in earnings due to the conservatism of GAAP, while equation (2) does not. An

advantage of equation (2), however, is that it allows for the stock price impact of both levels and

changes in earnings documented in the prior literature, while equation (1) does not.

We develop a composite index of the above three individual metrics (REV_SLOPE,

REV_R2, and ERC_R2) as our primary metric of the timeliness of earnings. We calculate the

percentile rank for each firm in the sample for each of the three metrics. Thus each firm has three

percentile values corresponding to its relative value of each of the three metrics. The composite

timeliness metric for a given firm, EARN_TIMELY, is computed for a firm as the average of all

three percentile rank values. In addition to providing an aggregate metric that captures the

various aspects of timeliness reflected in each individual metric, the use of a composite involving

percentile ranks provides for a metric that may mitigate potential measurement error in the

timeliness metrics (Greene, 1999).18 We also report results using the first principal component of

the three individual timeliness metrics as another attempt to address potential measurement error.

Our metrics may be impacted by several sources of measurement or specification error.

First, measurement error may result from our reliance on stock prices as estimates of equity

value. The severity of this measurement error depends on the extent to which stock prices are

strong-form efficient. If stock prices fully reflect managers’ private information, our reliance on

stock price does not introduce measurement error into our timeliness metrics. However, in the

likely scenario that stock prices are not strong-form efficient, measurement error could affect the

likelihood of detecting the predicted relation between our timeliness metrics and governance

structures. Second, alternative sources of financial information will impact our measurement of

recognition of holding gains on assets in place over the lives of the assets to increase the slope in model 2
(analogous to positive effects of the persistence in earnings on ERCs documented in the prior literature). In
contrast, we expect distortions in earnings resulting from mismatching of revenues and expenses to
decrease the slope in equation (2).
18
The use of the ranks of the timeliness metrics will mitigate measurement error in the metrics only if the
rank is determined by 'timeliness' rather than the measurement error in metrics.

14
earnings timeliness. To the extent that accounting information is less timely, alternative sources

of financial information are expected to play a larger role in determining stock prices.

A third potential source of error may result from our use of earnings, a summary

accounting measure, to capture the usefulness of accounting information in general. While we

expect that boards of directors use disaggregated accounting information to assess operating,

investing and financing activities in the governance process, our empirical design makes it

practically difficult to utilize a large vector of disaggregated accounting information in our

estimations.19 Thus, our measures of timeliness represent a lower bound on the ability of current

accounting information to incorporate current value-relevant information reflected in stock prices.

While we expect the inter-firm differences in the timeliness of accounting numbers described in

the prior section to result in differences in the timeliness of earnings, we acknowledge that the

rankings of the timeliness of earnings may differ from those of the timeliness of disaggregate

accounting information.

In addition to using the percentile ranks of individual metrics in our timeliness composite

measure in all of our analyses to mitigate measurement error, we present analyses that control for

factors that may be related to the measurement or specification error discussed above. We

include a metric capturing the extent of financial information provided by alternative sources

based on involvement by financial intermediaries in the firms’ information environment.

Financial intermediaries, such as analysts, may impact the amount and quality of information

available to market participants. Also, to the extent that analyst following is correlated with the

timeliness of information, there may be a direct impact on our metric as analysts disseminate

information used by investors in setting security prices. We include #ANALF, the number of

analyst long-term earnings growth rate forecasts for the firm (from the Zacks database), as a

19
Our argument suggests that even if disaggregated accounting information explains 100 percent of the
change in equity value, it does not become superfluous to governance because a single stock price measure
is not a sufficient statistic for the detailed operational information available from disaggregated accounting
information.

15
measure of the number of analysts following a firm.20 We also include metrics capturing the

extent of geographic (CONC_GEOG) and industry (CONC_IND) aggregation in each firms’

earnings using data from the Compustat Business Industry Segment files. We expect that our

measures of the timeliness of earnings will do a better job capturing the timeliness of a firms’

broader set of accounting information if the firm operations are more homogeneous in product

line and location. We compute Hirfindahl-Hirschman Indices measuring within-firm

concentration by industry and geographic segment computed as the sum of the square of a firms’

sales in a particular segment as a percentage of total firm sales. Higher values of CONC_GEOG

and CONC_IND indicate more geographic and industry concentration, respectively, within the

firm. We, thus, expect CONC_GEOG and CONC_IND to be negatively correlated with the loss

of information from the aggregation of information in overall earnings for each firm. The results

of analyses reflecting the information environment and aggregation control variables are

discussed in section 5.

3. Development of hypotheses and description of governance variables

This section develops our hypotheses concerning the sensitivity of governance structures

to the timeliness of earnings and provides a brief description of our governance variables. 21

3.1 Board composition

Our first set of predictions concerns the composition of the board of directors. Fama

(1980) and Fama and Jensen (1983) argue that a board’s effectiveness in monitoring its firm’s

20
An alternative measure of the amount of financial information from alternative sources would be the
extent of management voluntary disclosure. We expect the demand for information of both types to be
positively correlated. Related, it is possible that in addition to an impact on our EARN_TIMELY metric,
analyst following is endogenous to the timeliness of earnings and institutional following, with a greater
number of analysts following firms for which accounting information is not timely or which have large
institutional followings. Likewise, management disclosure may be endogenous to ownership structure.
O'Brien and Bhushan (1990) explore the link between analyst and institutional followings. The relations
among alternative sources of financial information (e.g., analyst following and management disclosure) and
both the timeliness of earnings and institutional following are examined in Chen, Engel and Smith (1999).
21
Details concerning the computation of governance variables are provided in the appendix.

16
managers is a function of the mix of inside and outside directors. They suggest that an optimal

board should consist of both inside and outside directors: inside directors for their in-depth

knowledge of firm specific activities and the firm’s competitive environment, and outside

directors for their independence and monitoring skills. They also suggest that the effectiveness of

the board as a monitoring mechanism is enhanced by outside directors who have labor market

incentives to develop reputations as experts in decision control. Beyond these insights, there

exists little formal theory concerning the endogenous determination of optimal board composition

(recent exceptions include Hermalin and Weisbach (1998) and Warther (1998)).

An empirical investigation of board composition is found in Hermalin and Weisbach

(1988). They hypothesize and find evidence that the CEO succession process and firm

performance lead to changes in board composition. Denis and Sarin (1999) document that

changes in ownership and board structures are correlated with each other and are related to top

executive turnover, firm performance and the threat of takeover. A more common approach in

the academic literature involves linking observed board configurations and characteristics with

the future performance of the firm (see Bhagat and Black (1998) for an extensive review of this

literature). We are unaware of any studies that attempt to explain board composition at a point in

time using a cross-sectional design.

We predict that the composition of the boards of firms whose accounting numbers are of

relatively little use for evaluating current managerial and firm performance will facilitate the

collection, sharing, and processing of more alternative sources of information. We predict that

the size of the board is smaller to facilitate frequent and intense information sharing and

processing. We proxy for board size with the total number of directors on the board (#_DIR).

We also predict that the board will consist of a higher proportion of inside directors because of

insiders’ in-depth knowledge of firm-specific activities and the firm’s competitive environment.22

22
Inside directors are officers, retired officers, or relatives of officers of the sample firm. Outside directors
are directors who are not officers, retired officers, or relatives of officers of the sample firm. Managers can

17
We also expect a higher portion of insiders on the boards of these firms due to succession

planning; i.e. to allow the outside directors more opportunity to observe the qualifications of top

managers. Successors to the CEO are arguably more likely to be selected from insiders of these

firms because of the high relative value of insiders' industry and firm-specific knowledge.23 We

include the percentage of directors who are insiders (%INDIR) to capture to proportion of insider

directors.

Although we expect insiders’ in-depth knowledge to be of greater potential benefit to

boards of firms whose current accounting numbers provide little information about the effects of

current activities and outcomes on equity value, we also expect a greater potential benefit from

intense policing and advising activities by outside directors. Hence, we expect a higher

proportion of the outside directors to have management experience in the same industry because

of the in-depth knowledge such experience provides of the growth opportunities, production

functions, competitive environments, risk factors etc. faced by firms in the industry. We capture

outside director expertise in the firm’s industry by computing the percentage of outside directors

who have had executive experience in the same Fama and French (1997) industry grouping as the

sample firm (%_EXPERT). We also expect outside directors to be of higher quality (i.e.

reputation) which, following Shivdisani (1993), we measure with the average number of other

boards on which outside directors serve.

We compute a composite variable for board composition for each firm (GOV_BOARD)

as the average of the within- sample percentiles of each of the four board characteristics.

%INDIR, %_EXPERT, and #OTH_BOARD are sorted in ascending order, while #_DIR is sorted

be required to attend board meetings without being members of the board. To the extent that this occurs, it
is likely to weaken the hypothesized relation between the timeliness of accounting information and the
percentage of directors who are insiders.
23
Borokhovich, Parrino, and Trapani (1996) document a positive relation between the portion of outside
directors and the likelihood of selecting a CEO from the outside. This may be because of the lower relative
importance of detailed firm-specific knowledge and expertise for both the CEO and the directors in some
firms.

18
in descending order before computing percentiles because we expect board monitoring to

decrease with #_DIR and to increase with the other board characteristics. Hence, we interpret

high values of GOV_BOARD as indicative of board structures that facilitate costly monitoring.

3.2 Equity-based incentives of inside and outside directors

Our second set of predictions concerns the stockholdings of inside and outside directors.

Holdings of stock directly link directors’ financial incentives with those of outside shareholders.

We predict that the stockholdings of inside directors will be relatively large in firms whose

earnings provide relatively little help in alleviating information asymmetries between managers

and outside investors. This is because of the greater benefits of providing inside directors with

equity-based incentives to act in the shareholders’ interest in fulfilling their managerial and board

responsibilities. We also predict that the stockholdings of outside directors will be large to

provide the outside directors with powerful financial incentives to engage in costly policing and

advising activities for the benefit of the shareholders.

To capture the equity-based incentives of inside and outside directors during fiscal 1994,

we include the average value and percentage of outstanding shares of common stock held by

individual inside directors (STKVAL_INDIR and STK%_INDIR) and by individual outside

directors (STKVAL_OUTDIR and STK%_OUTDIR). The average value of shares held by

individual inside directors (STKVAL_INDIR) is computed by multiplying the number of shares

held by each inside director at the end of fiscal 1994 by the fiscal year end stock price, and then

averaging across inside directors. The average percentage of shares held by individual inside

directors (STK%_INDIR) is computed by dividing the number of shares held by each inside

director at the end of fiscal 1994 by the total number of shares outstanding on that date, and then

averaging across inside directors. STKVAL_OUTDIR and STK%_OUTDIR are computed in an

analogous fashion based on stockholdings of outside directors. We also consider the combined

value and percentage of all officers and directors as a group at the end of fiscal 1994

19
(STKVAL_GRP and STK%_GRP). We compute composite variables to capture the strength of

equity-based incentives of inside directors (GOV_INDIR), outside directors, (GOV_OUTDIR),

and all officers and directors as a group (GOV_GRP). Each composite variable represents the

average within-sample percentiles of the percentage and value of shares held by the

corresponding group. In all cases, the variables are sorted in ascending order before computing

percentile values, so that high values of the composite variables represent relatively large

shareholdings.

3.3 Equity-based incentives of outside shareholders

Our third prediction concerns the relation between the timeliness of accounting numbers

and the concentration of stock held by outsiders (i.e., neither officers nor directors). We predict

that the lower the timeliness of earnings, the higher the concentration of stock ownership by

outside shareholders in response to the benefits of costly monitoring. This prediction is based on

arguments made by Demsetz and Lehn (1985) who posit that the concentration of stock

ownership is endogenously determined, at least in part, by the potential benefits of costly

shareholder monitoring. Their basic theory is that a shareholder with a “small” equity stake in the

firm has relatively weak incentives to engage in costly monitoring activities. This is because the

“small” stockholder bears all of the costs, but reaps a small share of the benefits of his monitoring

activities. In contrast, a stockholder with a large equity stake has relatively strong incentives to

engage in costly monitoring if the total potential benefits of monitoring are high. This is because

the large stockholder stands to gain a large share of the benefits from costly monitoring activities.

Demsetz and Lehn (1985) predict that the total potential benefits of monitoring increase with the

volatility of a firm’s operating environment, such as instability of a firm’s input and output prices.

They proxy for the benefits of monitoring by the standard deviation of stock returns and

accounting returns.

20
 To capture the concentration of stock ownership by outside investors, we include the

average value and percentage of stock held by individual investors other than officers and

directors at the end of fiscal 1994 and the percent of stock held by institutions. The average value

of stock held by individual outside investors (STKVAL_SHLDR) is computed as the total market

value of outstanding common stock at the end of fiscal year 1994 minus the value of shares held

by officers and directors as a group, divided by the number of common shareholders.24 The

average percentage of stock held by individual outside investors (STK%_SHLDR) is computed as

the reciprocal of the number of common stockholders as of fiscal year end 1994. The percentage

of stock held by institutions (%INST) is computed as the number of shares held by institutions

divided by the total number of common shares. We compute a composite variable for the equity-

based incentives of outside shareholders (GOV_SHLDR) representing the average within-sample

percentile of STKVAL_SHLDR, STK%_SHLDR and %INST. Each of the three individual metrics

are sorted in ascending order before computing the percentile values. Hence, high values of

GOV_SHLDR represent relatively large average shareholdings by individual outside

shareholders.

3.4 Executive compensation

Our final set of predictions concerns the composition of executive compensation

packages. In the U.S., the compensation packages of top executives typically consist of a base

salary component and an incentive component. The incentive component often is comprised of

an annual bonus plan and one or more long-term incentive plans, where the payoffs of these plans

depend on an intricate portfolio of performance measures.

Bushman, Indjejikian and Smith (1996) and Ittner, Larcker, and Rajan (1997) empirically

investigate the actual mix of performance measures used in top executives’ annual bonus plans,

24
Ideally we would exclude the number of officers and directors from the denominator. However, the
measurement error from not doing so is likely to be small because the number of officers and directors is
small relative to the total number of common stockholders.

21
and what factors determine this mix. They document evidence consistent with greater use of

individual performance measures (including subjective judgements by the board) and non-

financial performance measures relative to the use of accounting numbers among firms focused

on growth and innovation, and firms with long product development cycles. Firms characterized

by growth, innovation and long product development cycles are firms that we conjecture will

have current earnings that do a relatively poor job of capturing the effects of managers’ current

activities on equity value. Their results are thus consistent with the idea that firms with poor

accounting systems will substitute away from accounting numbers in annual bonus plans toward

the use of non-financial and individual performance measures.

In this paper, we do not have detailed performance measure information. However, we

adopt a version of the substitution argument used in Bushman, Indjejikian and Smith (1996) and

Ittner, Larcker, and Rajan (1997). We predict that as the timeliness of accounting earnings

declines, executive compensation packages will include both a higher proportion of equity-based

incentives and a higher proportion of long-term incentives relative to total incentives. The

argument for the shift towards equity-based pay is simply that untimely earnings lead to a heavier

emphasis on forward-looking stock prices to align incentives. Besides equity-based pay, long-

term incentive plans sometimes depend on earnings measured over three to five year time

horizons. As the time period increases over which earnings are measured, the more fully

accounting numbers are expected to reflect changes in equity value (see for example Easton,

Harris and Ohlson (1992)). Thus, to the extent that earnings measured on an annual basis have

limited use, we predict that firms will shift towards long-term plans where earnings are measured

over longer periods.25

To capture the structure of incentive packages of the top five officers we include the

percentage of the value of all their incentive plans represented by equity-based plans

25
Smith and Watts (1992) and Gaver and Gaver (1993) find the use of long-term incentive plans, including
equity-based plans, increase with the firms’ investment opportunity set measured in various ways.

22
(EQINC_TOT ) and by long-term plans (LTINC_TOT ). We compute the value of all incentive

plans during a year as the combined value of options and restricted stock granted that year as well

as long-term performance plan payouts and annual bonus payments during the year. EQINC_TOT

is the percentage of total incentives represented by grants of stock options and restricted stock,

and LTINC_TOT is the percent of managers’ total incentive plans represented by grants of options

and restricted stock plus any payouts from long-term performance plans (excludes annual bonus

payments). For each measure we use the average of the ratio of across the top five officers of a

firm in each year 1994-97, and then average over the four years to minimize distortions

associated with non-annual option grant frequencies. We compute a composite variable

(GOV_EXEC) as the average of the percentiles of EQINC_TOT and LTINC_TOT. Both

EQINC_TOT and LTINC_TOT are sorted in ascending order before computing percentiles so that

high values of GOV_EXEC represent relatively high importance of long-term and equity-based

incentive plans and relatively low importance of short-term bonus plans.

In addition to composite governance measures of board composition, equity-based

incentives of directors and outside shareholders and executive compensation, we compute an

overall composite governance measure, GOV_ALL, capturing the underlying metrics in each of

these areas. GOV_ALL is computed as the average of the percentiles of #_DIR, %INDIR,

%_EXPERT, #OTH_BOARD, STKVAL_GRP, STK%_GRP, STKVAL_SHLDR, STK%_SHLDR,

LTINC_TOT and EQINC_TOT with all metrics sorted in ascending order with the exception of

#_DIR which is sorted in descending order.

4. Control variables, sample, and data

4.1 Control variables

We include a number of additional variables in our cross-sectional regression models of

corporate governance structures in an attempt to control for the effects of other factors. In our

basic analyses, we include two control variables motivated by Demsetz and Lehn (1985) - the

23
standard deviation of stock returns (STD_RET) as a measure of uncertainty or volatility of firms’

operating environments, and the log of the market value of equity (MV) as a measure of firm size.

Demsetz and Lehn (1985) provides evidence of a significant relation between these factors and

ownership concentration. We expect a positive association between our governance structure

variables and STD_RET in the spirit of greater volatility of a firm’s operating environment

leading to the need for more costly monitoring mechanisms. We do not offer specific predictions

on the association between the various governance structures variables and MV, rather we include

MV as a control for the impact on the governance structure variables of various unspecified

differences that relate to size (e.g., information environment, marginal product of manager effort).

In additional analyses we consider control variables to determine whether our timeliness

metrics have significant incremental explanatory power over and above certain firm

characteristics that have been examined in prior research on governance systems.26 The

additional variables capture factors such as the firm’s investment opportunity set and performance

history and the influence of the CEO within the firm. The specific other firm characteristics

included in the analyses are the ratio of the market value of equity to the book value of equity

(MTB) and sales growth (GROWTH_SALE), the number of years a firm has been public

(FIRM_AGE), a measure of the firm’s prior performance (ROE), the number of years the CEO

has been a director of the firm (CEO_TENURE) and an indicator variable for whether the CEO is

a founder of the firm (FOUNDER). With the exception of STD_RET, FIRM_AGE and

FOUNDER, all of the control variables are measured as the average over the period of 1989 to

1993. FIRM_AGE is measured by the number of years a firm has been on CRSP as of year-end

1994 and STD_RET is estimated over the same period used to estimate models (1) and (2).

FOUNDER is a dummy variable that takes a value of one if the CEO or Chairman of the Board in

place during 1994 is also a founder of the firm and zero otherwise.

24
4.2 Sample and data

Our sample is selected from the Fortune 1000 firms included on ProxyBase, a database

maintained by Hewitt Associates of compensation and board of directors’ information from

annual proxy statements of firms. We obtain data for fiscal year 1994 from ProxyBase on the

number of directors, the number of inside versus outside directors, and directors' stock ownership.

We also obtain from ProxyBase data for 1994-97 on the structure of the compensation packages

of the top five officers. We obtain data concerning the percentage of stock held by officers and

directors as a group (as reported in proxy statements for fiscal year 1994) from Compact

Disclosure. We collect data from proxy statements for fiscal 1994 concerning the backgrounds of

outside directors, including the number of other boards on which they currently serve, and current

and prior employers. We get data from Compustat on 4-digit SIC codes of sample firms and

current / prior employers of outside directors to assess whether outside directors have industry-

specific expertise from serving as an executive of another firm in a given sample firm's industry.

For this analysis, we assign firms to industries on the basis of the classification scheme reported

in Fama and French (1997).27 We require sample firms to have data on annual earnings and the

market value of equity on Compustat for at least eight years during the period 1985 through 1994.

Finally we require that monthly stock return data for at least eight years during the period 1985 to

1994 are available from CRSP for estimating 15-month stock returns. All other data are from

Compustat.

Table 1 describes the industry membership of the 784 sample firms assigned on the basis

of 4-digit SIC codes and the Fama-French (1997) industry classification scheme. Forty-five

industries are represented by sample firms, with twenty six industries represented by at least ten

26
See Smith and Watts (1992), Kole (1996), Hermalin and Weisbach (1998), Denis and Sarin (1999),
Hubbard, Himmelberg and Palia (1999), among others, for studies of various governance systems and their
determinants.
27
We make one change to the Fama and French (1997) industry classification scheme; we classify SIC code
7372 (Prepackaged Software) as Computers rather than Business Services.

25
firms. Utilities (97 firms), banks (81 firms), insurance (45 firms), retail (42 firms), chemicals (33

firms), wholesale (33 firms), computers (31 firms), machinery (30 firms), petroleum and natural

gas (29 firms), business supplies (28 firms), and business services (25 firms) are each represented

by at least twenty five firms.

Table 2 summarizes the sample distribution of our metrics for the timeliness of earnings.

The mean and median levels of the ERC_R2 are 0.37 and 0.35, respectively, while the mean and

median levels of REV_R2 are 0.33 and 0.29, respectively.28 REV_SLOPE, the slope on positive

returns in equation (2), has mean (median) value of 0.04 (0.03). Table 2 also summarizes the

sample distribution of other firm characteristics considered in our governance estimations,

including the market value of equity (MV), the standard deviation of 15-month stock returns

(STD_RET), firm age (FIRM_AGE), the market-to-book ratio (MTB), sales growth

(GROWTH_SALE), return on equity of prior years (ROE), CEO tenure and CEO founder

information (FOUNDER). Information environment variables used to examine potential

measurement error in our timeliness metrics are also reported (i.e., #ANALF, CONC_GEOG, and

CONC_IND). Finally, Table 2 summarizes the sample distribution of all governance variables

considered, including variables reflecting board composition, equity-based incentives of inside

and outside directors, equity-based incentives of all officers and directors as a group, equity-

based incentives of outside investors, and the composition of executives’ incentive packages.

The descriptive statistics in Table 2 reveal that all model variables display a fair amount of

variation across sample firms.

5. Empirical design and results

This section describes the design of our empirical tests and the results. We first examine

28
We expect the measures, ERC_R2 and REV_R2, to be correlated since the regressions they relate to
involve similar variables. The R2 values are not identical however, since an additional independent
variable is include in each equation (i.e., the change in earnings is included in the ERC_R2 model and a
dummy variable to distinguish negative returns is included in the REV_R2 model).

26
correlations between our composite metrics of earnings timeliness and governance structures with

the variables underlying them to validate that the composites are capturing the data of interest.

We then present our empirical model of the relation between governance variables and the

metrics for the timeliness of earnings, controlling for other factors that have been hypothesized to

influence governance structures in prior research. We also present the results of analyses that

incorporate variables expected to be linked with measurement error in our timeliness metric and

analyses that disaggregate the volatility of stock returns as a complement to tests in Demsetz and

Lehn (1985).

5.1 Correlations of individual and composite timeliness and governance structure variables

Panel A of Table 3 reports Pearson and Spearman rank correlations between pairs of

individual earnings timeliness metrics, and between individual metrics and the composite

timeliness metric (EARN_TIMELY) constructed from the sample percentiles of the individual

metrics. Correlations between all three individual timeliness metrics are positive and highly

significant. The Spearman correlation between the ERC_R2 and REV_R2 is the highest of the

three at 0.41, and the correlation between REV_R2 and REV_SLOPE is the lowest of the three at

0.27.29 The composite metric, EARN_TIMELY, is highly positively correlated with each of the

three individual metrics ranging from 0.72 with REV_SLOPE to 0.80 with ERC_R2. Taken

together, these correlations suggest that our individual metrics for the timeliness of the

information in the accounting system are linked. Further, the significant correlations between the

composite and individual metrics suggest that our use of sample percentiles of individual metrics

to compute the composite metric appears to be capturing the essence of the individual metrics.

The table also includes correlations between the timeliness metrics and the overall composite

governance metric, GOV_ALL. The correlations between GOV_ALL and the individual and

composite timeliness metrics are all negative and highly significant, consistent with our

27
prediction that firms will substitute costly governance mechanisms to compensate for less useful

accounting numbers.

Our empirical analyses focus on several key governance structures – board composition,

stockholdings of inside and outside directors, stockholdings of officers and directors as a group,

stockholdings of outside shareholders, and executive compensation packages. We use multiple

variables to capture each governance structure and we develop a single composite variable for

each governance structure. We validate our composite variables for each governance structure

category by examining the pairwise correlations between the variables underlying each composite

variable and between each composite variable and its underlying individual variables. Panels A

and B of Table 4 report the Pearson and Spearman rank correlations of the individual and

composite variables grouped by governance structure. The reported table values indicate

significant correlations between pairs of variables within categories of governance structures, and

between the composite variable and the multiple individual variables for each category. In

aggregate, the generally significant correlations between individual variables in each governance

structure category, as well as their correlation with the corresponding composite variable suggest

that the individual variables are capturing related phenomena, and that the use of average

percentiles for aggregating individual variables into a composite variable captures the essence of

the individual variables.

The Panel C of Table 4 reports correlations between composite measures for the various

governance structures. The table suggests significant correlations across many categories of

governance variables. Although the relation among the governance structures is not the focus of

this study, the correlations provide some preliminary descriptive evidence of such relations. Also,

the panel documents that the overall composite governance structure metric, GOV_ALL, is highly

correlated with each of the other composite metrics.

29
The discussion in the paper addresses Spearman rank correlations. However, the Pearson correlations are
generally similar to the Spearman correlations in both magnitude and significance.

28
5.2 Primary model and regression results

Our primary empirical analyses involve OLS estimations of the cross-sectional relation

between governance structure variables and metrics for the timeliness of earnings. We first

estimate regressions for the composite governance variables against the three individual earnings

timeliness metrics (ERC_R2, REV_R2 and REV_SLOPE), and against the composite earnings

timeliness metric (EARN_TIMELY). As discussed in section 4.1, we include the log of the market

value of equity (MV) and the standard deviation of firms’ stock returns (STD_RET) to control for

factors related to firm size and volatility, respectively. Our empirical model is:

DEP_VAR = α + β ACCOUNTING_METRIC + δ1MV + δ2STD_RET + ε (3)

DEP_VAR represents a composite governance variable for the board composition, equity-based

incentives of inside or outside directors, equity-based incentives of all officers and directors as a

group, equity-based incentives of outside shareholders, or the composition of executive

compensation plans. For each DEP_VAR variable whose value is bounded between zero and one,

we apply a logistic transformation before estimating the model.30 ACCOUNTING_METRIC

represents the composite earnings timeliness metric, EARN_TIMELY, or one of its three

underlying metrics (ERC_R2, REV_R2 or REV_SLOPE).

Our main interest is β , the slope of the timeliness metrics. The composite governance

variables are constructed so that high values represent governance systems that facilitate costly

monitoring activities by directors and investors, and that rely more heavily on executive incentive

plans other than annual bonus plans. Our basic prediction is that firms whose current accounting

30 é DEP _ VAR ù
Specifically, we use the formula log ê ú to transform observations. The transformation is
ë (1 − DEP _ VAR) û
designed to convert the bounded distribution into an unbounded one. We apply the transformation to each
governance composite metric along with, %INDIR, %_EXPERT, STK%_OUTDIR, STK%_INDIR,
STK%_GRP, STK%_SHLDR, %INSTN, LTINC_TOT and EQINC_TOT. The transformation is similar to
that conducted by Demsetz and Lehn (1985) and Himmelberg, Hubbard, and Palia (1999) in a similar
setting. The reported results for the transformed variables are similar to results using the variables before
conducting the transformation.

29
numbers do a relatively poor job of capturing the effects of current activities and outcomes on

equity value will rely more heavily on these costly governance mechanisms to compensate for

their untimely earnings. Hence, we predict β <0 to reflect the negative relation between the

composite governance variables and the metrics for the timeliness of earnings.

Table 5 reports regression results for equation (3) of the composite governance variables

against each of the three individual earnings timeliness metrics (ERC_R2, REV_R2 and

REV_SLOPE), and against the composite earnings timeliness metric (EARN_TIMELY). The first

row for each dependent variable reports the estimated coefficients for the explanatory variables and

the second row reports t statistics (in parentheses). White’s t-statistics (not reported) are

qualitatively similar to those reported in each table.

The results in Table 5, Panel A indicate that the estimated coefficients on ERC_R2 and

REV_R2 have the predicted negative sign and are significant at the 1% level for each composite

governance variable. The results in Panel B indicate that the estimated coefficients for

REV_SLOPE also are significantly negative, as predicted, for each composite governance variable

with the exceptions of GOV_BOARD and GOV_OUTDIR, which are negative but not significant.

Adjusted R2 levels from the three sets of regressions using individual earnings timeliness metrics

range from 0.04 to 0.13.

Results also are reported in Panel B for the composite timeliness metric (EARN_TIMELY).

EARN_TIMELY averages the sample percentiles of the raw underlying levels of the three individual

measures of accounting timeliness (ERC_R2, REV_R2 and REV_SLOPE). Given the aggregate

nature of the composite timeliness metric and its potential to mitigate potential measurement error

through its use of ranks of individual metrics, we view our analyses using EARN_TIMELY as our

primary test of the relation between corporate governance structures and the timeliness of earnings.

The estimated coefficients for EARN_TIMELY are significant at the 1% level with the predicted

30
negative sign in all governance regressions.31 The combined explanatory power of EARN_TIMELY

and the two control variables (the market value of equity (MV) and the standard deviation of stock

returns (STD_RET)) ranges from a low of five percent in the model for GOV_OUTDIR to a high of

17 percent in the model for GOV_ALL.

Table 6 reports the results of estimating equation (3) for the composite governance

variables as well as their underlying individual governance variables as DEP_VAR against our

composite earnings timeliness metric, EARN_TIMELY. These analyses allow us to determine

which individual governance variables underlying the composite governance variables contribute to

the significant results in Table 5. We predict that all of the individual governance variables will be

negatively related to EARN_TIMELY except for the number of directors (#_DIR) for which we

predict a positive relation with EARN_TIMELY.

In the board composition category, the coefficient on EARN_TIMELY is negative and

significant as predicted in the regression model for the percentage of inside directors, %INDIR, and

in the model for the number of other boards on which outside directors serve, #OTH_BOARD. In

contrast, the coefficient on EARN_TIMELY has the predicted sign, but is not significant in the

regression models for either the total number of directors (#_DIR) or the percentage of outside

directors that are experts (%EXPERT).

In the category of director equity-based incentives, the results in Table 6 indicate that the

coefficient on EARN_TIMELY is negative and significant as predicted in the regression models

relating to the value and percentage of shares owned by inside directors (i.e., STKVAL_INDIR and

STK%_INDIR) but is not significant in the model relating to outside director incentives (i.e.,

STKVAL_OUTDIR and STK%_OUTDIR. As Table 2 indicates, the magnitude and variation of

outside director incentives is quite small, with over three-quarters of outside directors holding no

equity of the firm. This may explain why individual metrics do not result in significant relations

31
Results (not tabulated) using the first principal component of the three individual earnings timeliness as a
'composite' metric are qualitatively similar to those using EARN_TIMELY.

31
with EARN_TIMELY while the composite metric using variable percentiles is significantly

negatively related with EARN_TIMELY. The results of the estimations of the equity-based

incentives of the officers and directors as a group indicate that the coefficient on EARN_TIMELY is

negative and significant as predicted both the value and percentage of shares held by officers and

directors as a group (i.e., STKVAL_GRP and STK%_GRP).

In the category of equity-based incentives of outside shareholders (i.e. other than officers

and directors), the results in Table 6 indicate that the coefficient on EARN_TIMELY is negative and

significant as predicted in the regression models for each of the three individual metrics of outside

shareholder incentives, STKVAL_SHLDR, STK%_SHLDR and %INSTN. Finally, in the category

of the compensation packages of executives, the coefficient on EARN_TIMELY is negative and

significant as predicted in regression models for both long-term (LTINC_TOT) and equity-based

(EQINC_TOT) incentives.

5.3 Control variables and additional analyses

In Table 7 we report results of estimating cross-sectional regressions for composite

governance variables against EARN_TIMELY with additional control variables as follows:

DEP_VAR = α + β EARN_TIMELY + δ1 MV + δ2STD_RET + δ3FIRM_AGE +δ4 MTB

+ δ5GROWTH_SALE + δ6ROE + δ7CEO_TENURE +δ8FOUNDER + ε. (4)

In addition to the control variables for firm size and stock return volatility included in

equation (3), equation (4) includes variables to control for firm age, investment opportunity set,

prior sales growth, prior performance measure by return on equity, CEO tenure and whether the

CEO or Chairman of the Board is a founder of the firm. Regressions based on equation (4) are

intended to provide insights into 1) whether EARN_TIMELY has significant explanatory power

with respect to the composite governance variables over and above that of several firm

characteristics found to be related to governance structures in prior research, and 2) whether

32
governance structures behave as if these other firm characteristics affect governance structures

primarily through their effect on the timeliness of earnings.

The results in Table 7 indicate that the coefficient on EARN_TIMELY remains negative and

significant, as predicted, in the model for each composite governance variable after including the

additional control variables. The results suggest that EARN_TIMELY has incremental explanatory

power over and above the control variables for firm age, investment opportunity set, sales growth,

prior firm performance, CEO tenure and the founder's active involvement in firm governance as

well as the original control variables for firm size and the volatility of stock returns.32 We also

examine the combined incremental explanatory power of the new controls for firm characteristics

hypothesized in prior research to be related to ownership structures. F-tests for the joint significance

of the control variables (FIRM_AGE, MTB, GROWTH_SALE, ROE, CEO_TENURE and

FOUNDER) reject the null hypothesis in the estimation for each composite governance variable (p-

values of 0.01 or less). The incremental significance of this group of firm characteristics suggests

that these firm characteristics are associated with governance structures over and above any effects

they may have through the timeliness of earnings.33

As discussed in section 2, we develop several control variables to address potential

measurement or specification error in our earnings timeliness metrics related to the firm’s

information environment and the use of the summary earnings number. We re-estimate equation

(3) for the composite governance and timeliness metrics after including the control variables

capturing the extent of analyst following of a firm (#ANALF) and measures of the degree of

geographic (CONC_GEOG) and industry (CONC_IND) aggregation of information within the firm.

32
We also estimated equation (4) substituting each of the three individual metrics of earnings timeliness
included in Table 5 for EARN_TIMELY. The results (not reported) produce significant, negative
coefficients on the individual metrics with the exception of the coefficients on REV_SLOPE in the
regression involving the governance categories for board composition and equity incentives of outside
directors.
33
We also examined the impact of the intensity of research and development (RD_SALE), advertising
(AD_SALE) and capital investments (PPE_TA) on the governance metrics with similar results. These
metrics are hypothesized determinants of both governance structures and earnings timeliness. Inclusion of

33
We offer no specific prediction on the signs of the control variables, rather we include them to

examine the robustness of EARN_TIMELY to the inclusion of variables hypothesized to be linked

with the measurement error in EARN_TIMELY. Univariate correlations (not tabulated) show that

#ANALF is significantly negatively correlated with EARN_TIMELY suggesting that greater analyst

following is associated with reduced relative market share of earnings with respect to stock prices.

CONC_GEOG and CONC_IND display significant, positive correlation with EARN_TIMELY

which is consistent with the use of summary earnings in our metric displaying higher levels of

relative timeliness when firms are more concentrated firms. The results of the estimations with the

additional controls, reported in Table 8, show that the coefficients on EARN_TIMELY remains

significant and negative, as predicted, in each governance structure regression. The results suggest

the controls for the firms’ information environment and extent of aggregation of information in

earnings for a firm do not impact the association between earnings timeliness and the governance

structures examined.

We next report results of estimations that build on the analyses of Demsetz and Lehn

(1985). Demsetz and Lehn hypothesize that the concentration of corporate stock ownership is

positively related to the instability of firms’ operating environments as reflected in the volatility of

their stock returns due to the greater benefits of monitoring. Our analyses extend Demsetz and

Lehn in two ways. First, we examine regressions for multiple aspects of firms’ governance

systems. To the extent that the volatility of firms’ operating environments increases the demand for

monitoring as hypothesized in Demsetz and Lehn (1985), a positive relation between return

volatility and all of our composite governance variables is expected. Second, we decompose firms’

stock return volatility into two components – the portion that can be explained by contemporaneous

these factors does not impact the significance of EARN_TIMELY in the governance models. We explicitly
consider these factors in our tests of endogeneity of earnings timeliness in section 6.

34
earnings (EARN_VAR) and the portion that cannot (OTHER_VAR). We estimate the following

model: 34

DEP_VAR = α1 + β 1EARN_VAR +β 2OTHER_VAR + δ1MV+ ε, (5)

We expect to reject the null hypothesis that the coefficients on the two components of stock

return volatility are equal (H0: β 1 = β 2 ). Rejection of the null hypothesis is consistent with our

premise that corporate governance structures behave as if the effects of volatility on the demand for

costly monitoring depend on whether the volatility is captured within the accounting system or not.

Furthermore, we expect that β 2 will be significantly greater than β 1. That is, we expect that the stock

return variation that is not explained by contemporaneous earnings creates a greater demand for

costly monitoring than the return variation that is explained by contemporaneous earnings. This is

consistent with our premise that the cost to investors and directors of evaluating changes in equity

value that are captured in the accounting system is relatively low.

The results of estimating equation (5) for each composite governance variable are presented

in Table 9. F-tests of the null hypothesis of equal coefficients on EARN_VAR and OTHER_VAR (as

assumed in Demsetz and Lehn (1985), among others) are rejected at the 1% level for all composite

governance variables except for the composite variable for the equity-based incentives of outside

directors (GOV_OUTDIR). These F-tests provide support for our prediction that the impact of

stock return variation on corporate governance systems depends on whether the changes in equity

value are explained by contemporaneous earnings. Furthermore, in the regression models for all

composite governance variables, the coefficient on OTHER_VAR is significantly positive while the

coefficient on EARN_VAR is not significant. These results support the prediction that the volatility

34
Equation (5) presents an adaptation of our model to allow an interpretation of our results in the context of
those in Demsetz and Lehn. Note that our first set of estimations in Panel A of Table 5 involve ERC_R2,
the proportion of total return volatility explained by earnings, along with a measure of total standard
deviation of returns (STD_RET). While similar in spirit to the analyses of components of return volatility
in equation (5), the coefficients on the components of return volatility (EARN_VAR and OTHER_VAR)
cannot be derived directly from Table 5 for two reasons: 1) the earlier tables measure the standard
deviation of returns while equation (5) is based on the variance of returns and 2) ERC_R2 captures the
proportion of return volatility while the components of volatility reflect magnitudes.

35
of equity value not explained by earnings has a greater effect on the demand for costly monitoring

mechanisms than the volatility of equity value explained by contemporaneous earnings. We

interpret this as additional support for the view that the cost to investors and directors of collecting

and processing accounting numbers is relatively low, and that firms substitute costly monitoring

mechanisms to compensate for the failure of current accounting numbers to fully capture the effects

of current activities and outcomes on equity value.

6. Sensitivity Analyses

6.1 Endogeneity of earnings timeliness metrics

In this section we discuss and address the issue of potential endogeneity of the earnings

timeliness metrics. A large earnings management literature addresses how flexibility in GAAP

allows managers to strategically impact earnings. Several studies view corporate governance

structures as the cause of GAAP earnings properties.35 Although earnings management is an

important phenomenon, its ability to impact many fundamental information properties of GAAP

accounting numbers may be limited by structural factors, particularly over longer time horizons.

The audit and regulatory oversight of financial reporting and ultimate reversal of many

discretionary accruals suggest that firm's ability to manage earnings over the long-term may be

curtailed. The earnings management literature has had limited success in documenting the

prevalence and economic importance of earnings management or the extent to which the

activities impact information relayed in financial reports and decisions of market participants. A

potential error of our original specification is that governance structures may influence the extent

of management discretion in the timing with which revenues and expenses are recognized, which,

in turn, may affect our earnings timeliness metrics. While management discretion can affect the

35
See Healy and Wahlen (1998) for a review of the earnings management literature. Studies that address
corporate governance issues include Healy (1985), Gaver and Gaver (1995) and Holthausen, Larcker and
Sloan (1995) which address the impact of executive bonus plan structures on earnings manipulation and

36
level of reported earnings in any year, the nature of these effects on our timeliness metrics is not

clear. The issue of potential endogeneity of the properties of accounting numbers with respect to

the corporate governance structures examined in our paper remains an empirical question that we

explore in this section.

We address this issue in our research design in several ways. First, our timeliness metrics

are based on “core” earnings, defined as earnings before special items, extraordinary items and

discontinued operations. The focus on core earnings, rather than bottom line earnings, is

motivated in part by the desire to exclude from the earnings measure the effects of discretionary

accruals within special items, extraordinary items and discontinued operations.

Second, we attempt to distinguish between differences in our timeliness metrics

attributable to exogenous firm characteristics (e.g. production functions, market and investment

opportunities) and differences attributable to management discretion. We expect earnings

management to be largely a firm-specific phenomenon. In contrast, we expect production

functions and investment and market opportunities to be largely industry-related. Hence, we

explore the extent to which our prior results are due to inter-industry versus intra-industry effects.

To the extent that our results are driven by inter-industry effects, we are less concerned about our

assumption that the timeliness metrics are exogenous.36 We re-estimate equation (3) to analyze

the inter-industry and intra-industry variation in the governance and timeliness variables. We

first examine inter-industry effects by estimating equation (3) using industry means of all model

variables. We then examine intra-industry effects by estimating equation (3) using firm

deviations from industry means for each variable.

Warfield, Wild and Wild (1995) which examines the impact of ownership structures on discretionary
accrual levels and the 'informativeness' of accounting earnings.
36
Our metrics of accounting timeliness exhibit a fair amount of variation both across industries and among
firms within the same industry (not reported). Management discretion, if present, is likely to explain
relatively more of the variation of our metrics across firms in the same industry vs. across firms in different
industries.

37
 Table 10 presents the results of the inter-industry and intra-industry analyses. The first set

of columns reports the results of the inter-industry analyses using the industry averages of all

industries with more than 5 firms in our sample (n=29). The second set of columns reports results

using the intra-industry approach. The results of the inter-industry analyses indicate that

EARN_TIMELY is significant (at the 5% level) for all governance structure metrics except those

relating to the equity-based incentives of inside directors (GOV_INDIR) and the compensation

packages of executives (GOV_EXEC). In contrast, the intra-industry analyses reveal that

EARN_TIMELY is significant in the GOV_INDIR and GOV_EXEC regressions. These results

suggest that inter-industry variation explains a greater portion than does intra-industry variation

of the relation between the composite earnings timeliness metric and board composition, equity-

based incentives of outside directors, equity-based incentives of officers and directors as a group,

and equity-based incentives of outside shareholders. In contrast, the relation between the

timeliness of earnings and both executive stock holdings and compensation packages appears to

be influenced more by intra-industry variation.37 If intra-industry variation in the composite

timeliness metric is relatively more attributable to management discretion than to fundamental

characteristics of the firm, the result may suggest that our timeliness metrics are a positive

endogenous function of the relative importance of annual bonus plans within executives’

incentive packages.

Overall, the results of the inter-industry and intra-industry analyses reveal that inter-

industry variation explains a large part of the relation between our governance variables (other

than executive incentives) and our timeliness metrics. Given that relatively more of the across

industry variation in earnings timeliness metrics is likely due to differences in fundamental firm

37
The importance of firm and manager-specific factors (i.e., firm production functions, managers’ risk
aversion, manager's outside employment alternatives) in developing optimal incentive contracts is
consistent with the finding of agency models (see Holmstrom (1979) and Grossman and Hart (1983) among
others).

38
characteristics than management discretion, these results mitigate the concerns of estimation bias

in our earlier analyses related to the endogeneity of our accounting timeliness metrics.

Third, we more directly examine endogeneity of our timeliness metrics by conducting a

two-stage estimation procedure designed to provide a test for the endogeneity of the accounting

timeliness metrics and overcome potential estimation bias that may be present in the ordinary

least squares estimations presented earlier.38 We develop a system of equations that includes the

governance structure models presented in equation (4) as well as a model that allows timeliness

of accounting earnings to be a function of governance structures. We model EARN_TIMELY as a

function of each of the four governance structures and several other variables related to the

production functions and investment and market opportunities of firms that are hypothesized to

impact the properties of accounting earnings. These variables include the market value of equity

(MV), the volatility of stock returns (STD_RET), investment opportunity set (MTB and

GROWTH_SALE), research and development intensity (RD_SALE), advertising intensity

(AD_SALE) and capital intensity (PPE_TA). Specifically we estimate a system of 5 equations:

Timeliness model:

EARN_TIMELY = λ + γ1GOV_BOARD + γ2GOV_GRP + γ3GOV_SHLDR + γ4GOV_EXEC

+ θ1 MV + θ2STD_RET +θ3MTB + θ4GROWTH_SALE + θ5RD_SALE
+ θ6AD_SALE + θ6PPE_TA + η (6)

Governance structure models (4 equations):

DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + δ 3 FIRM _ AGE + δ 4 MTB

(7)
+ δ 5 GROWTH _ SALE + δ 6 ROE + δ 7 CEO _ TENURE + δ 8 FOUNDER + ε

where DEP_VAR represents one of the four key composite governance metrics we examine (i.e.,

GOV_BOARD, GOV_GRP, GOV_SHLDR and GOV_EXEC), RD_SALE is the ratio of R&D

38
We first conduct Hausman's (1978, 1983) test to determine whether the assumption of endogeneity of the
earnings timeliness proxy with respect to the governance structures is appropriate. The results of the tests
for each governance structure metric suggest that EARN_TIMELY may be endogenous to GOV_GRP and
GOV_SHLDR but that estimation bias is not likely an issue with GOV_BOARD and GOV_EXEC.

39
 expense to sales, AD_SALE is the ratio of advertising expense to sales, PPE_TA is the ratio of

property, plant and equipment to total assets and all other variables are as previously defined.39

The results of the estimations for the four governance structures models using two-stage

least squares are presented in Table 11. We find that the results of the estimations relating to the

timeliness metric are consistent with those reported in Table 7 using ordinary least squares

estimation. Specifically, we find that EARN_TIMELY is significant and negative, as predicted,

for each of the four governance composite metrics. The explanatory power of the estimations is

similar in magnitude to those in Table 7 for the GOV_BOARD and GOV_GRP models and

slightly lower than the previous results in the GOV_SHLDR and GOV_EXEC estimations. The

results of the estimation of the EARN_TIMELY model in equation (6) (not tabulated) indicate that

none of the governance composite metrics is significant. Overall, the two-stage least squares

results from estimating equations (6) and (7) suggest that estimation bias does not appear to be a

significant empirical issue in the OLS estimations relating to the role of earnings timeliness in the

governance models. Collectively, the alternative specifications presented in this section provide

no evidence consistent with the endogeneity of EARN_TIMELY with respect to the governance

composite measures.40

6.2 The role of regulation

Regulation may impact the governance structure of a firm due to additional third-party

monitoring. The impact will likely be greatest in regulated industries that involve significant

additional controls such as price (i.e., rate) or profitability controls found in the utilities industry.

Demsetz and Lehn document that ownership structure is less concentrated in the regulated utilities

39
We also report in Table 11 the results of estimating a system of two equations by substituting the four
governance equations with a single equation capturing our overall composite governance metric,
GOV_ALL. The results using GOV_ALL are consistent with those involving the system described above.
40
Despite our alternative specifications and analyses, we are hesitant to conclude that earnings timeliness is
not endogenous to governance structures. Inferences about endogeneity from our two-stage estimation
results are dependent on the success with which we found appropriate instruments for the analysis. Further,
inclusion of the correlated governance structure composites in the model of EARN_TIMELY may produce

40
industry. To the extent that the presence of regulation of this sort impacts the governance structure

by requiring less monitoring by directors and investors and less long-term and equity-based

incentives for executives, our models may be misspecified.

We conduct sensitivity analyses of the importance of regulation to our primary results in

two ways: 1) by including an industry dummy variable for the utilities industry and 2) by estimating

our analyses on all sample firms excluding the utilities firms. The utilities industry dummy variable

takes a value of 1 if a firm is a regulated utility, and zero otherwise. We re-estimate our main

analyses in Tables 5 and 7 with the addition of the utility dummy. The results of the regressions with

the inclusion of the utility dummy are qualitatively similar for all governance structure variables and

earnings timeliness metrics with the exception of the equity-based incentives for outside board

members in the Table 5 analyses and for inside and outside board member incentives in the Table 7

analyses. Our estimations of the models in Table 5 and 7 on the subset of non-utility firms produce

similar results to those with the utility dummy in that earnings timeliness metrics for the estimations

involving inside and outside director incentive are no longer significant. The timeliness metrics for

all other governance structure variables remain significantly negative. Re-estimations of the system

of equations (Table 11) which include a utility dummy variable and which exclude utilities firms

similarly produce negative, significant coefficients on all earning timeliness metrics except those

relating to board member equity-based incentives (GOV_GRP). The results suggest that controlling

for a systematic impact of utilities regulation does not affect the relation between the timeliness of

earnings and board composition, equity-based incentives of outside shareholders, or compensation

packages of executives.

the insignificant coefficient estimates we observe due to the high correlation between the governance
composite measures observed in Panel C of Table 4.

41
7. Summary and implications

We predict that governance systems of large public U.S. corporations are a function of

the timeliness of firms’ accounting numbers. We focus on earnings as the summary measure from

the firm’s accounting system. We argue that the usefulness of earnings in a governance setting

depends on the extent to which current earnings capture the effects of current activities and

outcomes on shareholder value. We also argue that there are likely to be significant differences in

this regard among large public companies in the U.S. arising from differences in their production

functions and their investment and market opportunities. To identify these inter-firm differences,

we use firm-specific regressions between contemporaneous earnings and stock returns to estimate

metrics of the timeliness of their earnings, defined by Ball, Kothari, and Robin (2000) as the

extent to which current earnings incorporate current economic income or value-relevant

information.

We predict the governance systems of firms whose earnings are relatively untimely will

be characterized by board and ownership structures that facilitate costly monitoring activities by

shareholders and directors to compensate for the shortcomings of earnings. To test our predictions

concerning the sensitivity of corporate governance systems to the timeliness of earnings, we

estimate proxies for the composition of the board, the equity-based incentives of inside and

outside directors, the equity-based incentives of all officers and directors, the equity-based

incentives of outside shareholders, and the composition of executive compensation packages for a

sample of Fortune 1000 firms. We estimate the cross-sectional relation between each governance

proxy and our metrics for the timeliness of firms’ earnings, controlling for numerous other firm

characteristics. Our results largely support our predictions, providing support for our joint

hypothesis that 1) the demand for costly information collection and processing by shareholders

and directors is an inverse function of the usefulness of signals from the accounting system, 2)

that an important determinant of the usefulness of signals from the accounting system is their

ability to explain current changes in shareholder value, and 3) specified governance structures

42
characterized by costly oversight activities are a response to the strength of the demand for costly

information collection and processing by shareholders and directors. Our results are robust to

sensitivity analyses addressing measurement error in our metrics of earnings timeliness, the roles

of regulation and financial intermediation in the governance process, and alternative

specifications addressing the issue of endogeneity of earnings timeliness.

Although our results are consistent with the predicted effects of the timeliness of earnings

on corporate governance systems, we acknowledge that we must be careful in inferring causality.

While we document the incremental explanatory power of the timeliness metrics in the

governance regressions over and above a number of factors considered in prior research involving

governance structures, it is possible that our metrics are picking up the effects of omitted

correlated variables. Subject to this caveat, our results document evidence that multiple aspects

of governance systems of large public companies in the U.S. vary in predictable ways with the

extent to which their current earnings incorporate current value relevant information. This adds to

prior evidence that corporate ownership structures vary with other firm characteristics expected to

affect the demand for monitoring.

Our paper also is linked to the capital market and stewardship literatures in accounting.

Much of existing research into the stewardship relevance and research into the value relevance of

accounting have proceeded independently. We address the issue of whether the usefulness of

accounting numbers in equity valuation appears to “matter” in the determination of corporate

governance systems of large public companies in the U. S. Although we cannot draw causal

inferences from our analysis, we view associations between measures of the usefulness of

accounting numbers and governance structures as a necessary (although not sufficient) condition

for concluding that governance structures are influenced by the limitations of accounting

numbers.

Finally, our paper may have implications for future research into other economic

consequences of accounting. Our results largely support the predicted relation between timeliness

43
metrics and subsequent governance structures. This evidence supports the notion that the firm-

specific timeliness metrics used here capture meaningful differences across large public U.S.

companies in the information properties of accounting numbers. This provides additional

confidence that such firm-specific metrics can be used by researchers to investigate other

economic consequences of the information properties of accounting, such as voluntary

disclosures, corporate signaling, analyst activity, corporate investment decisions, financing

choices, and the cost of debt and equity capital.

44
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Smith, C. and R. Watts, 1992. The Investment Opportunity Set and Corporate Financing,
Dividend, and Compensation Policies. Journal of Financial Economics 32, 263-92.

Verrecchia, R., 1982. The Use of Mathematical Models in Financial Accounting. Journal of
Accounting Research, 20, 1-55.

Verrecchia, R., 1983. Discretionary Disclosure. Journal of Accounting and Economics 5, 179-
94.

Warfield, T., J. Wild and K. Wild, 1995. Managerial Ownership, Accounting Choices, and
Informativeness of Earnings. Journal of Accounting and Economics 20, 55-100.

Warther, V., 1998. Board Effectiveness and Board Dissent: A Model of the Board's Relationship
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Organization 4, 53-70.

47
 Appendix: Model Variable Measurement
Dependent variables: (All the dependent variables are calculated at their 1994 values except for
LTINC_TOT and EQINC_TOT which are averaged over 1994-97).
Board Composition:
#_DIR: total number of directors;
%INDIR: (number of inside directors) / #_DIR;
%_EXPERT: (number of expert outside directors)/(number of outside directors), where a director
is coded as expert if he has had experience as an executive in the same industry);
#OTH_BOARD: (total number of other boards outside directors serve on) / (number of outside
directors);
GOV_BOARD: average of percentile ranks of #_DIR (descending), %INDIR (ascending),
%_EXPERT (ascending) and #OTH_BOARD (ascending);
Board and Officer Incentives:
STKVAL_INDIR : (average number of common shares owned by each inside director) * (stock price at
1994 fiscal year end);
STK%_INDIR: (average number of shares owned by each inside director) / (total number of
common shares outstanding at 1994 fiscal year end);
GOV_INDIR: average of percentile ranks of STKVAL_INDIR (ascending) and STK%_INDIR
(ascending);
STKVAL_OUTDIR: (average number of common shares owned by each outside director) * (stock price
at 1994 fiscal year end);
STK%_OUTDIR: (average number of shares owned by each outside director) / (total number of
common shares outstanding at 1994 fiscal year end);
GOV_OUTDIR: average of percentile ranks of STKVAL_OUTDIR and STK%_OUTDIR (ascending);
GOV_ALLDIR: average of percentile ranks of STKVAL_INDIR, STKVAL_OUTDIR, STK%_INDIR
and STK%_OUTDIR (ascending);
STKVAL_GRP: (total number of common shares owned by all directors and officers) * (stock price
at 1994 fiscal year end);
STK%_GRP: (number of shares owned by all directors and officers) / (total number of common
shares outstanding at 1994 fiscal year end);
GOV_GROUP: average of percentile ranks of STKVAL_GRP and STK%_GRP (ascending);
Outside Shareholder Incentives:
STKVAL_SHLDR: (market value of common stock - value of stock held by officers and directors) /
(number of common shareholders at 1994 fiscal year end).
STK%_SHLDR: 1/(number of common shareholders at 1994 fiscal year end);
%INSTN: (number of shares held by institutions)/(total number of common shares outstanding
at 1994 fiscal year end)
GOV_SHLDR: average of percentile ranks of STKVAL_SHLDR, STK%_SHLDR and %INSTN
(ascending);
Executive Incentives:
LTINC_TOT: (value of grants of long-term incentives) / (value of grants of long-term incentives
plus annual bonuses);
EQINC_TOT: (value of grants of equity-based incentives)/(value of grants of long-term incentives
plus annual bonuses);
GOV_EXEC: average of percentile ranks of LTINC_TOT (ascending) and EQINC_TOT;
(ascending);

GOV_ALL: average of percentile ranks of #_DIR (descending), %INDIR (ascending),

%_EXPERT (ascending), #OTH_BOARD (ascending), STKVAL_GRP (ascending),
STK%_GRP (ascending), STKVAL_SHLDR (ascending), STK%_SHLDR
(ascending), LTINC_TOT (ascending) and EQINC_TOT (ascending);

48
 Appendix: Model Variable Measurement (continued):

Measures of earnings timeliness:

ERC_R2: R2 of the firm-specific regression of 15-month (ending three months after fiscal year end)
stock return on the level of and change in annual core earnings, both deflated by market
value of equity at the beginning of the period. Each regression starts from 1985 and has at
least 8 years of observations. Fisher transformation of the R2 is used in the regression
estimations. The percentile ranking, Rank_ERC_R2, (ascending) of the Fisher
transformed ERC_R2 is included in EARN_TIMELY (composite);
REV_R2: R2 of the firm-specific regression of annual earnings deflated by price at the beginning of
the period on 1) 15-month (ending three months after fiscal year end) stock return and 2)
an interactive variable of the 15-month stock return times a dummy variable = 1 if the 15-
month stock return is negative. Each regression starts from 1985 and has at least 8 years
of observations. Fisher transformation of the R2 is used in the regression estimations.
The percentile ranking, Rank_REV_R2, (ascending) of the Fisher transformed REV_R2 is
included in EARN_TIMELY (composite);
REV_SLOPE: The estimated coefficient on the 15-month positive stock return from the model described
in REV_R2 above. The percentile ranking, Rank_REV_SLOPE, (ascending) is included
in EARN_TIMELY (composite);
EARN_TIMELY : average of Rank_ERC_R2, Rank_REV_R2 and Rank_REV_SLOPE;

Note: All of the following variables are the average values of the variable over 1989 to 1993.

Other Firm Characteristics (Table 7)

MV: market value of equity (stock price #199* number of common shares outstanding #25);
STD_RET: standard deviation of the dependent variable in the ERC regression;
FIRM_AGE: number of years a firm has been included in the CRSP database as of the end of 1994;
MTB: ratio of market value of equity to book value of common equity;
GROWTH_SALE: growth rate of net sales computed as (change in net sales)/(prior year net sales);
ROE: net income before extraordinary items (#18) / total shareholders' equity (#216)
CEO_TENURE: number of years the CEO has been a director of the firm;
FOUNDER: dummy variable equal to 1 if CEO or Chairman of the Board is a founder of the firm;
zero otherwise;

Characteristics of firm information environment (Table 8)

#ANALF: the number of analyst long-term earnings growth rate forecasts for the firm from the
Zacks database;
CONC_GEOG: the sum of the square of a firms’ sales in each geographic segment (reported in
Compustat Business Industry Segment file) as a percentage of total firm sales.
CONC_IND: the sum of the square of a firms’ sales in each industry segment (reported in Compustat
Business Industry Segment file) as a percentage of total firm sales.

Components of stock return variance (Table 9)

EARN_VAR: the proportion of the variance of 15-month market returns that is explained by variation
in levels and changes in core earnings - computed as (STD_RET)2 times ERC_R2 ;
OTHER_VAR: the proportion of the variance of 15-month market returns that cannot be explained by
variation in levels and changes in core earnings - computed as (STD_RET)2 less
EARN_VAR;

Additional instruments for earnings timeliness in simultaneous equations analyses (Table 11)
RD_SALE: R&D expenses (#46) / net sales (#12);
AD_SALE: advertising expenses (#45) / net sales (#12);
PPE_TA: plant, property and equipment (#8) / total asset (#6);

49
 Table 1
Industry Membership of Sample Firms 1

INDUSTRY No. Firms INDUSTRY No. Firms

Agriculture 1 Measuring and Control Equipment 10

Aircraft 5 Medical Equipment 16
Alcoholic Beverages 3 Nonmetallic Mining 4
Apparel 8 Personal Services 1
Automobiles and Trucks 20 Petroleum and Natural Gas 29
Banking 81 Pharmaceutical Products 14
Business Services 25 Precious Metals 2
Business Supplies 28 Printing and Publishing 14
Candy and Soda 3 Recreational Products 6
Chemicals 33 Restaurants, Hotel, Motel 9
Computers 31 Retail 42
Construction Material 19 Rubber and Plastic Products 5
Construction 13 Shipbuilding, Railroad Equipment 6
Consumer Goods 22 Shipping Containers 4
Defense 2 Steel Works, etc. 14
Electrical Equipment 11 Telecommunications 16
Electronic Equipment 22 Textiles 10
Entertainment 2 Tobacco Products 2
Fabricated Products 1 Trading 5
Food Products 17 Transportation 21
Healthcare 2 Utilities 97
Insurance 45 Wholesale 33
Machinery 30 Total 784

1
Industries are defined on the basis of 4-digit SIC codes using the industry groupings identified in Fama
and French (1997). The only departure from the Fama and French industry groupings is our classification
of SIC code 7372 as Computers rather than Business Services.
 Table 2
Sample Distribution of Model Variables 1

VARIABLE NOBS MEAN STD. DEV Q1 MEDIAN Q3

Earnings timeliness metrics:
EARN_TIMELY 784 0.50 0.22 0.33 0.50 0.67
ERC_R2 784 0.37 0.23 0.17 0.35 0.55
REV_R2 745 0.33 0.21 0.16 0.29 0.47
REV_SLOPE 745 0.04 0.15 -0.01 0.03 0.09

Other firm characteristics:

MV ($ millions) 784 3347.85 7048.44 480.38 1083.08 2978.03
STD_RET 784 0.41 0.24 0.25 0.35 0.47
FIRM_AGE 783 30.07 17.98 22.00 24.00 39.00
MTB 784 2.53 5.69 2.62 1.76 1.37
GROWTH_SALE 784 0.09 0.13 0.03 0.06 0.12
ROE 784 0.10 1.18 0.07 0.11 0.15
CEO_TENURE 778 12.14 9.20 5.0 10.0 17.0
FOUNDER 784 0.14 0.35 0 0 0
Information environment variables:
#ANALF 784 13.87 8.72 18.80 12.20 7.00
CONC_GEOG 784 0.77 0.27 1.00 0.91 0.55
CONC_IND 784 0.58 0.25 0.76 0.56 0.36

Governance Structure Metrics:

Board Composition
%INDIR 784 0.22 0.12 0.13 0.20 0.28
#_DIR 784 11.22 3.30 9.00 11.00 13.00
%_EXPERT 756 0.08 0.14 0.00 0.00 0.13
#OTH_BOARD 757 2.08 1.16 1.17 2.00 2.83
Board Stock-based Incentives
STKVAL_INDIR (in $ millions) 780 37.90 235.17 3.04 9.06 21.91
STK%_INDIR 780 0.02 0.04 0.00 0.01 0.02
STKVAL_OUTDIR (in $ millions) 783 10.85 80.09 0.18 0.72 3.36
STK%_OUTDIR 783 0.00 0.02 0.00 0.00 0.00
Officer and Director Stock-based Incentives
STKVAL_GRP (in $ millions) 784 213.22 1224.45 17.59 52.90 135.31
STK%_GRP 784 0.08 0.12 0.01 0.03 0.10
Outside Shareholder Incentives
STKVAL_SHLDR (in $thousands) 776 268.11 445.35 62.80 151.31 308.34
STK%_SHLDR 753 0.19 0.22 0.03 0.10 0.26
%INSTN 782 0.53 0.20 0.38 0.56 0.68
Executives Stock-Based Incentives
LTINC_TOT 779 0.57 0.22 0.43 0.60 0.72
EQINC_TOT 779 0.49 0.24 0.32 0.51 0.67
1
For variable definitions, please refer to Appendix.
 Table 3

Correlations for individual and composite earnings timeliness metrics

and overall governance structure metric (GOV_ALL) 1, 2

Earnings Timeliness Metrics

ERC_R2 REV_R2 REV_SLOPE EARN_TIMELY GOV_ALL

ERC_R2 1.00 0.41* 0.37* 0.80* -0.24*

REV_R2 0.44* 1.00 0.27* 0.74* -0.15*

REV_SLOPE 0.21* 0.11* 1.00 0.72* -0.23*

EARN_TIMELY 0.80* 0.74* 0.46* 1.00 -0.26*

GOV_ALL -0.26* -0.17* -0.16* -0.28* 1.00

Legend and definition of variables

1
For variable definitions, please refer to Appendix.
2
Spearman rank (Pearson) correlations are reflected in the upper (lower) diagonal.
Variable names in bold indicate composite measure.
Correlations in bold denote significance at the 5% level.
Correlations in bold with asterisk (*) denote significance at the 1% level.
Correlations in shaded boxes reflect those between individual variables and corresponding composite variables.
 TABLE 4
Correlations for individual and composite governance structure metrics1
PANEL A: Spearman rank (upper diagonal) and Pearson (lower diagonal) correlations for equity-based incentive variables
STKVAL STK% GOV STKVAL STK% GOV STKVAL STK% GOV STKVAL STK% GOV
_INDIR _INDIR _INDIR _OUTDIR _OUTDIR _OUTDIR _GRP _GRP _GROUP _SHLDR _SHLDR %INSTN _SHLDR
STKVAL_INDIR 1.00 0.58* 0.88* 0.40* 0.12* 0.27* 0.75* 0.39* 0.64* 0.46* 0.08 0.19* 0.32*

STK%_INDIR 0.26* 1.00 0.89* 0.23* 0.49* 0.38* 0.32* 0.77* 0.61* 0.15* 0.64* 0.03 0.33*

GOV_INDIR 0.55* 0.65* 1.00 0.34* 0.34* 0.36* 0.59* 0.64* 0.70* 0.33* 0.39* 0.12* 0.35*

STKVAL_OUTDIR 0.06 -0.01 0.04 1.00 0.78* 0.94* 0.63* 0.48* 0.63* 0.37* 0.22* 0.06 0.28*

STK%_OUTDIR 0.00 0.14* 0.12* 0.30* 1.00 0.94* 0.31* 0.73* 0.59* 0.12* 0.58* -0.09 0.25*

GOV_OUTDIR 0.08 0.18* 0.37* 0.21* 0.43* 1.00 0.50* 0.64* 0.64* 0.26* 0.43* -0.01 0.28*

STKVAL_GRP 0.66* 0.18* 0.15* 0.16* 0.04 0.14* 1.00 0.56* 0.88* 0.51* 0.08 0.15* 0.32*

STK%_GRP 0.18* 0.57* 0.45* 0.08* 0.37* 0.37* 0.23* 1.00 0.88* 0.18* 0.66* -0.06 0.32*

GOV_GRP 0.20* 0.40* 0.71* 0.16* 0.29* 0.65* 0.24* 0.67* 1.00 0.38* 0.41* 0.04 0.35*

STKVAL_SHLDR 0.16* 0.04 0.16* 0.02 -0.02 0.12* 0.07 0.01 0.17* 1.00 0.36* 0.47* 0.84*

STK%_SHLDR 0.01 0.39* 0.34* -0.02 0.25* 0.35* -0.03 0.46* 0.36* 0.31* 1.00 0.06 0.64*

%INSTN -0.03 -0.14* 0.14* -0.02 -0.10* -0.01 -0.05 -0.24* 0.07 0.25* -0.03 1.00 0.70*

GOV_SHLDR 0.06 0.10* 0.39* 0.07 0.05 0.29* -0.00 0.07 0.38* 0.54* 0.54* 0.70* 1.00

Legend and definition of variables

1
For variable definitions, please refer to Appendix
Variable names in bold indicate composite measure.
Correlations in bold denote significance at the 5% level.
Correlations in bold with asterisk (*) denote significance at the 1% level.
Correlations in shaded boxes reflect those between individual variables and corresponding composite variables.
 TABLE 4 (cont’d)
Correlations for individual and composite governance structure variables

PANEL B: Spearman rank (upper diagonal) and Pearson (lower diagonal) correlations for board composition and executive
incentive variables
#OTH
%INDIR #_DIR %EXPERT _BOARD GOV_BOARD LTINC_TOT EQINC_TOT GOV_EXEC
%INDIR 1.00 -0.20* 0.05 -0.23* 0.60* -0.10* -0.08 -0.10*

#_DIR -0.16* 1.00 -0.09 0.27* -0.63* 0.08 -0.00 0.05

%EXPERT 0.12* -0.14* 1.00 -0.09 0.26* 0.02 0.04 0.03

#OTH_BOARD -0.50* 0.18* -0.11* 1.00 0.25* 0.17* 0.08 0.13*

GOV_BOARD 0.52* -0.60* 0.32* 0.28* 1.00 -0.00 0.02 0.00

LTINC_TOT -0.11* 0.08 -0.06 0.18* -0.02 1.00 0.82* 0.95*

EQINC_TOT -0.07 0.01 -0.01 0.07 0.00 0.82* 1.00 0.95*

GOV_EXEC -0.10* 0.03 -0.04 0.12* -0.00 0.93* 0.94* 1.00

PANEL C: Spearman rank (upper diagonal) and Pearson (lower diagonal) correlations for composite governance structure variables
GOV_OUTDIR GOV_INDIR GOV_GRP GOV_SHLDR GOV_BOARD GOV_EXEC GOV_ALL
GOV_OUTDIR 1.00 0.36* 0.64* 0.28* 0.00 0.01 0.35*

GOV_INDIR 0.37* 1.00 0.70* 0.35* 0.24* 0.11* 0.53*

GOV_GRP 0.65* 0.71* 1.00 0.35* 0.16* 0.06 0.59*

GOV_SHLDR 0.29* 0.39* 0.38* 1.00 0.28* 0.21* 0.77*

GOV_BOARD -0.00 0.23* 0.17* 0.29* 1.00 -0.02 0.54*

GOV_EXEC 0.01 0.11* 0.06 0.22* -0.00 1.00 0.50*

GOV_ALL 0.38* 0.57* 0.63* 0.79* 0.55*** 0.52* 1.00*

See legend on preceding page of table.
 Table 5
Summary statistics from regressions of governance variables on earnings timeliness metrics (ACCOUNTING_ METRIC),
size (MV), and volatility (STD_RET) 1
DEP _ VAR = α + βACCOUNTING_ METRIC + δ 1 MV + δ 2 STD _ RET + ε

Panel A: ACCOUNTING_ METRIC: ERC_R2 and REV_R2

ERC_R2 REV_R2
Pred. Adjusted Pred. Adjusted
DEP_VAR sign ERC_R2 MV STD_RET R2 Sign REV_R2 MV STD_RET R2

GOV_BOARD (-) -0.19 -0.03 0.41 0.06 (-) -0.20 -0.03 0.40 0.05
(-3.72)** (-2.18)** (5.10)** (-3.33)** (-2.29)** (4.67)**
GOV_INDIR (-) -0.72 -0.05 1.70 0.11 (-) -0.48 -0.04 1.83 0.09
(-5.31)** (-1.28) (8.00)** (-2.89)** (-1.11) (8.00)**
GOV_OUTDIR (-) -0.34 -0.17 0.67 0.05 (-) -0.48 -0.16 0.81 0.05
(-2.39)** (-4.44)** (3.64)** (-2.83)** (-4.18)** (3.43)**
GOV_ALLDIR (-) -0.49 -0.10 1.11 0.11 (-) -0.49 -0.10 1.20 0.10
(-4.79)** (-3.66)** (7.28)** (-3.95)** (-3.61)** (6.96)**
GOV_GRP (-) -0.77 0.00 1.35 0.09 (-) -0.58 0.01 1.43 0.06
(-5.82)** (0.12) (6.50)** (-3.56)** (0.14) (6.37)**
GOV_SHLDR (-) -0.54 -0.01 0.90 0.08 (-) -0.59 -0.03 0.98 0.08
(-5.60)** (-0.52) (5.95)** (-5.13)** (-1.04) (6.18)**
GOV_EXEC (-) -0.57 0.25 1.12 0.08 (-) -0.36 0.25 1.11 0.07
(-4.09)** (6.66)** (5.12)** (-2.19)** (6.51)** (4.83)**

GOV_ALL (-) -0.39 0.02 0.69 0.16 (-) -0.31 0.01 0.71 0.12
(-8.08)** (1.50) (9.23)** (-5.41)** (1.05) (8.74)**
See next page for notes to table.
 Table 5 (cont’d)
Summary statistics from regressions of governance variables on earnings timeliness metrics (ACCOUNTING_ METRIC),
size (MV), and volatility (STD_RET) 1

Panel B: ACCOUNTING_METRIC: REV_SLOPE and EARN_TIMELY

REV SLOPE EARN TIMELY

Pred. Adjusted Pred. EARN_ Adjusted
DEP_VAR sign REV_SLOPE MV STD_RET R2 Sign TIMELY MV STD_RET R2
GOV_BOARD (-) -0.20 -0.03 0.37 0.04 (-) -0.34 -0.03 0.39 0.06
(-1.57) (-2.04)* (4.29)** (-4.04)** (-2.52)** (4.89)**
GOV_INDIR (-) -0.89 -0.04 1.73 0.09 (-) -1.34 -0.07 1.64 0.12
(-2.64)** (-1.03) (7.54)** (-5.98)** (-1.80) (7.79)**
GOV_OUTDIR (-) -0.54 -0.16 0.74 0.04 (-) -0.65 -0.17 0.68 0.05
(-1.54) (-3.99)** (3.10)** (-2.80)** (-4.55)** (3.09)**
GOV_ALLDIR (-) -0.64 -0.09 1.13 0.09 (-) -0.93 -0.11 1.06 0.12
(-2.51)** (-3.32)** (6.53)** (-5.54)** (-4.15)** (6.69)**
GOV_GRP (-) -0.96 0.02 1.31 0.06 (-) -1.38 -0.02 1.28 0.09
(-2.88)** (0.33) (5.78)** (-6.32)** (-0.43) (6.19)**
GOV_SHLDR (-) -0.83 -0.02 0.88 0.06 (-) -1.04 -0.03 0.85 0.09
(-3.50)** (-0.78) (5.47)** (-6.57)** (-1.11) (5.65)**
GOV_EXEC (-) -0.66 0.26 1.02 0.07 (-) -0.91 0.24 1.06 0.08
(-1.93)* (6.68)** (4.14)** (-3.96)** (6.40)** (4.89)**
GOV_ALL (-) -0.60 0.02 0.78 0.13 (-) -0.68 0.01 0.65 0.17
(-4.89)* (1.23) (9.14)** (-8.68)** (0.54) (8.81)**
1
Summary statistics include coefficient estimates with t-statistics in parenthesis.
DEP_VAR = composite corporate governance variables used as dependent variables in the above regressions. See Appendix for descriptions and
measurement information for specific DEP_VAR and all other model variables.
** (*) significant at the 1% (5%) level - one-tailed test for ACCOUNTING_METRIC, two-tailed test for remaining variables.
 Table 6
Summary statistics from regressions of individual and composite governance variables on EARN_TIMELY,
size (MV), and volatility (STD_RET) 1

DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + ε

Pred. EARN_ Adjusted

DEP_VAR Sign TIMELY MV STD_RET R2

Board Composition
GOV_BOARD (-) -0.34(-4.04)** -0.03(-2.52)** 0.39(4.89)** 0.06
%INDIR (-) -0.07(-3.22)** -0.01(-2.33)** 0.12(5.49)** 0.06
#_DIR (+) 0.53(1.34) 0.85(13.04)** -1.91(-5.07)** 0.25
%_EXPERT (-) -0.00(-0.19) -0.01(-2.34)** 0.12(5.00)** 0.05
#OTH_BOARD (-) -0.35(-2.17)** 0.34(12.72)** -0.44(-2.85)** 0.23

Board and Officer Incentives

GOV_INDIR (-) -1.34(-5.98)** -0.07(-1.80) 1.64(7.79)** 0.12
STKVAL_INDIR (-) -18.10(-1.79)* 8.13(4.90)** 38.90(4.04)** 0.04
STK%_INDIR (-) -0.01(-2.26)** -0.01(-8.40)** 0.02(5.77)** 0.16

GOV_OUTDIR (-) -0.65(-2.80)** -0.17(-4.55)** 0.68(3.09)** 0.05

STKVAL_OUTDIR (-) -3.02(-0.91) 2.18(3.97)** 7.17(2.27) 0.02
STK%_OUTDIR (-) -0.00(-0.18) 0.00(-5.56)** 0.00(1.38) 0.05

GOV_ALLDIR (-) -0.93(-5.54)** -0.11(-4.15)** 1.06(6.69)** 0.12

GOV_GRP (-) -1.38(-6.32)** -0.02(-0.43) 1.28(6.19)** 0.09

STKVAL_GRP (-) -95.78(-2.06)** 60.64(7.92)** 172.68(3.91)** 0.08
STK%_GRP (-) -0.05(-2.44)** -0.03(-8.34)** 0.06(2.96)** 0.11

Outside Shareholder Incentives

GOV_SHLDR (-) -1.04(-6.57)** -0.03(-1.11) 0.85(5.65)** 0.09
STKVAL_SHLDR (-) -140.38(-3.60)** 40.60(6.43)** 253.28(6.87)** 0.10
STK%_SHLDR (-) -0.07(-2.39)** -0.08(-18.24)** 0.16(6.23)** 0.38
%INSTN -0.35(-5.13)** 0.05(4.80)** 0.17(2.59)** 0.07

Executive Incentives
GOV_EXEC (-) -0.91(-3.96)** 0.24(6.40)** 1.06(4.89)** 0.08
LTINC_TOT (-) -0.29(-3.52)** 0.10(7.54)** 0.31(3.98)** 0.09
EQINC_TOT (-) -0.27(-3.30)** 0.06(4.40)** 0.465(5.87)** 0.07

1
Summary statistics include coefficient estimates with t-statistics in parenthesis.
DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above regression
analyses. See Appendix for descriptions and measurement information for specific DEP_VAR composites and
all other model variables.
** (*) significant at the 1% (5%) level - one-tailed test for EARN_TIMELY, two-tailed test for remaining variables.
 Table 7
Summary statistics from regressions of composite governance variables
on EARN_TIMELY and various control variables 1
DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + δ 3 FIRM _ AGE + δ 4 M 2 B + δ 5 GROWTH _ SALE + δ 6 ROE
+ δ 7 CEO _ TENURE + δ 8 FOUNDER + ε

Pred. EARN_ FIRM_ GROWTH_ CEO_ δ3+δ4+δ5+ Adj.

DEP_VAR sign TIMELY MV STD_RET AGE MTB SALES ROE TENURE FOUNDER δ6+δ7+δ7=0? R2

GOV_BOARD (-) -0.30 -0.05 0.34 0.00 0.03 -0.06 -0.11 0.00 0.20 0.001 0.11
(-3.54)** (-3.09)** (3.96)** (1.62) (3.40)** (-0.38) (-0.69) (2.10)* (3.40) **

GOV_INDIR (-) -0.96 0.02 1.11 -0.01 0.03 -0.06 0.35 0.05 0.62 0.001 0.29
(-4.67)** (0.52) (5.31)** (-4.63)** (1.20) (0.16) (0.90) (9.53) ** (4.34) **
GOV_OUTDIR (-) -0.58 -0.11 0.05 -0.02 0.04 1.12 0.25 0.00 0.30 0.001 0.14
(-2.56)** (-2.83)** (0.20) (-6.13)** (1.41) (2.55)* (0.59) (0.43) (1.89)
GOV_ALLDIR (-) -0.76 -0.06 0.55 -0.01 0.03 0.57 0.30 0.02 0.39 0.001 0.27
(-4.85)** (-2.01)* (3.48)** (-6.55)** (1.29) (1.88) (1.00) (5.82) ** (3.63) **

GOV_GRP (-) -1.02 0.07 0.60 -0.02 0.05 0.26 -0.00 0.03 0.99 0.001 0.26
(-4.85)** (1.90) (2.92)** (-5.18)** (2.75)** (0.65) (-0.01) (5.74) ** (7.10) **

GOV_SHLDR (-) -1.03 -0.02 0.46 -0.01 0.05 1.12 -0.04 0.01 -0.12 0.001 0.15
(-6.57)** (-0.77) (2.88)** (-3.87)** (2.66)** (3.65)** (-0.13) (1.91) (-1.09)

GOV_EXEC (-) -0.93 0.25 1.06 0.00 0.03 0.25 -0.39 -0.01 -0.13 0.0134 0.10
(-4.01)** (5.98)** (4.50)** (-1.09) (1.36) (0.55) (-2.07)* (-2.16)** (-0.78)

GOV_ALL (-) -0.60 0.02 0.44 -0.00 0.03 0.36 -0.04 0.01 0.18 0.001 0.24
(-7.79)** (1.36) (5.69)** (-3.48)** (3.28)** (2.38)* (-0.25) (2.99)** (3.31)**
1
Summary statistics include coefficient estimates with t-statistics in parenthesis.
DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above regression analyses. See Appendix for
descriptions and measurement information for specific DEP_VAR composites and all other model variables.
** (*) significant at the 1% (5%) level - one-tailed test for EARN_TIMELY, two-tailed test for remaining variables.
 Table 8
Summary statistics from regressions of composite governance variables
on EARN_TIMELY and information environment control variables 1

DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + δ 3 ANALF + δ 4 DIV _ GEOG + δ 5 DIV _ IND + ε

Pred. EARN_ CONC_ CONC_ Adj.

DEP_VAR sign TIMELY MV STD_RET ANALF GEOG IND R2
GOV_BOARD (-) -0.21 -0.06 0.44 0.00 -0.23 -0.04 0.09
(-2.47)** (-2.52)** (5.47)** (0.82) (-3.30) (-0.45)

GOV_INDIR (-) -1.14 -0.05 1.77 -0.01 -0.69 -0.69 0.13

(-4.60)** (-0.74) (7.69)** (-0.44) (-1.60) (-3.02)**
GOV_OUTDIR (-) -0.53 -0.22 0.72 0.01 -0.02 -0.41 0.05
(-2.04)* (-3.24)** (2.97) (1.18) (-0.09) (-1.71)
GOV_ALLDIR (-) -0.78 -0.14 1.13 0.01 -0.19 -0.52 0.13
(-4.25)** (-2.83)** (6.61)** (0.61) (-1.25) (-3.06)**

GOV_GRP (-) -1.21 -0.01 1.34 -0.00 -0.36 -0.43 0.09

(-4.96)** (-0.07) (5.87)** (-0.42) (-1.80) (-1.93)

GOV_SHLDR (-) -0.95 0.03 0.85 -0.02 -0.84 -0.29 0.14

(-5.59)** (0.74) (5.35)** (-2.52)* (-6.03)** (-1.85)

GOV_EXEC (-) -0.68 0.06 0.82 0.04 -0.66 0.07 0.12

(-2.70)** (0.91)** (3.53)** (3.41)** (-3.18)** (0.31)

GOV_ALL (-) -0.54 -0.04 0.66 0.00 -0.42 -0.10 0.21

(-6.60)** (-0.22)** (8.51)** (0.10) (-6.22)** (-1.29)
1
Summary statistics include coefficient estimates with t-statistics in parenthesis.

DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above regression
analyses. See Appendix for descriptions and measurement information for specific DEP_VAR composites and all
other model variables.

** (*) significant at the 1% (5%) level - one-tailed test for EARN_TIMELY, two-tailed test for remaining
variables.
 Table 9
Summary statistics from regressions of governance variables on components of stock return volatility
(EARN_STDRET and OTHER_STDRET), and size (MV)1

DEP _ VAR = α + β 1 EARN _ STDRET + β 2 OTHER _ STDRET + δ 1 MV + ε

EARN OTH p-value of F-

test of β1=β2 Adjusted R
2
DEP_VAR _STDRET _STDRET MV

GOV_BOARD -0.05 0.60 -0.03 0.001 0.06

(-0.43) (5.53)** (-1.96)*

GOV_INDIR 0.14 2.17 -0.04 0.000 0.10

(0.44) (7.49)** (-1.00)
GOV_OUTDIR 0.22 0.79 -0.16 0.148 0.05
(0.67) (2.65)** (-4.18)**
GOV_ALLDIR 0.14 1.38 -0.09 0.001 0.10
(0.59) (6.37)** (-3.38)**

GOV_GROUP -0.14 1.89 0.02 0.000 0.06

(-0.43) (6.69)** (0.45)

GOV_SHLDR 0.11 1.13 -0.01 0.004 0.05

(0.48) (5.48)** (-0.21)

GOV_EXEC -0.03 1.47 0.26 0.003 0.07

(-0.08) (4.97)** (6.78)**

GOV_ALL -0.15 1.02 0.02 0.001 0.12

(-1.28) (9.86)** (1.66)

1
Summary statistics include coefficient estimates with t-statistics in parenthesis.

DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above
regression analyses. See Appendix for descriptions and measurement information for specific DEP_VAR
composites and all other model variables.

** (*) significant at the 1% (5%) level.

 Table 10
Summary statistics from regressions of composite governance variables on EARN_TIMELY,
size (MV), and volatility (STD_RET) ) using inter-industry and intra-industry variables 1

DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + ε

Inter-industry variables Intra-industry variables

Pred. EARN_ Adjusted Pred. EARN_ Adjusted
DEP_VAR sign _TIMELY MV STD_RET R2 sign TIMELY MV STD_RET R2
GOV_BOARD (-) -0.90 -0.06 0.68 0.38 (-) -0.10 -0.02 0.30 0.02
(-2.47)** (-1.56) (2.23)** (-1.19) (-1.52) (3.73)**

GOV_INDIR (-) -0.02 -0.22 0.27 0.11 (-) -0.43 -0.06 1.01 0.04
(-0.02) (-2.26)** (0.36) (-2.09)** (-1.68) (5.18)**
GOV_OUTDIR (-) -1.89 -0.18 0.77 0.22 (-) -0.04 -0.18 0.09 0.03
(-1.96)** (-1.61) (0.95) (-0.19) (-4.63)** (0.43)
GOV_ALLDIR (-) -1.49 -0.16 0.90 0.21 (-) -0.20 -0.11 0.49 0.05
(-1.69)* (-1.55) (1.22) (-1.31) (-4.35)** (3.42)**

GOV_GRP (-) -2.64 -0.07 1.37 0.17 (-) -0.25 -0.00 0.47 0.01
(-2.11)** (-0.48) (1.31) (-1.28) (-0.14) (2.53)**

GOV_SHLDR (-) -2.35 -0.24 1.21 0.45 (-) -0.11 0.04 0.19 0.00
(-2.85)** (-2.57)** (1.75) (-0.83) (1.94) (1.46)

GOV_EXEC (-) -0.19 0.25 1.74 0.05 (-) -0.65 0.20 0.67 0.04
(-0.15) (1.77) (1.65) (-2.72)** (4.98)** (2.94)**

GOV_ALL (-) -1.26 -0.05 0.87 0.42 (-) -0.16 0.03 0.34 0.04
(-3.04)** (-1.02) (2.52)* (-2.46)** (2.59)** (5.34)**
1
Summary statistics include coefficient estimates with t-statistics in parenthesis.
DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above regression analyses. See Appendix for
descriptions and measurement information for specific DEP_VAR composites and all other model variables.
** (*) significant at the 1% (5%) level - one-tailed test for EARN_TIMELY, two-tailed test for remaining variables.
 Table 11
Summary statistics from simultaneous regressions of composite governance variables
on EARN_TIMELY and full set of control variables 1
System of equations:
Equation 1: EARN_TIMELY = λ + γ1GOV_BOARD + γ2GOV_GRP + γ3GOV_SHLDR + γ4GOV_EXEC + θ1 MV + θ2STD_RET
+θ3MTB + θ4GROWTH_SALE + θ5RD_SALE + θ6AD_SALE + θ6PPE_TA + η (not tabulated)
DEP _ VAR = α + βEARN _ TIMELY + δ 1 MV + δ 2 STD _ RET + δ 3 FIRM _ AGE + δ 4 M 2 B + δ 5 GROWTH _ SALE + δ 6 ROE
Equations 2 through 5:
+ δ 7 CEO _ TENURE + δ 7 FOUNDER + ε

Pred. EARN_ GROWTH_ CEO_ Adjusted

DEP_VAR sign TIMELY MV STD_RET FIRM_AGE MTB SALES ROE TENURE FOUNDER R2
GOV_BOARD (-) -1.22 -0.08 0.37 0.00 0.04 -0.13 0.30 0.00 0.16 0.09
(-1.65)* (-2.30)* (3.56)** (1.56) (2.50)* (-0.67) (1.26) (0.50) (1.94)

GOV_GRP (-) -6.19 -0.10 0.86 -0.01 0.02 -0.25 2.24 0.02 0.60 0.15
(-2.77)** (-1.31) (2.73)** (-3.44)** (0.50) (-0.45) (3.14)** (1.71) (2.47)*

GOV_SHLDR (-) -12.13 -0.33 0.61 -0.01 -0.06 0.84 2.84 -0.02 -0.93 0.02
(-3.45)** (-2.73)** (1.24) (-1.34) (-0.08) (0.95) (2.54)* (-1.37) (-2.42)*

GOV_EXEC (-) -3.83 0.16 1.16 -0.00 0.03 0.02 -0.37 -0.02 -0.24 0.06
(-1.76)* (2.18) (3.82)** (-0.34) (0.70) (0.04) (-0.53) (-2.32)* (-0.99)

GOV_ALL (-) -4.50 -0.10 0.54 -0.00 0.01 0.16 1.03 -0.00 -0.10 0.07
(-3.50)** (-2.11)* (2.94)** (-1.47) (0.30) (0.49) (2.47)* (-0.83) (-0.67)
1
Summary statistics include coefficient estimates with t-statistics in parenthesis.
DEP_VAR = variables reflecting composite corporate governance used as dependent variables in the above regression analyses. See Appendix for
descriptions and measurement information for specific DEP_VAR composites and all other model variables.
** (*) significant at the 1% (5%) level - one-tailed test for EARN_TIMELY, two-tailed test for remaining variables.