Corporate Governance and Earnings Management ...

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Corporate Governance and Earnings Management in the European Football Industry Panagiotis Dimitropoulos

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Department of Sport Management, University of Peloponnese, Sparta, Greece Available online: 21 Nov 2011

To cite this article: Panagiotis Dimitropoulos (2011): Corporate Governance and Earnings Management in the European Football Industry, European Sport Management Quarterly, 11:5, 495-523 To link to this article: http://dx.doi.org/10.1080/16184742.2011.624108

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European Sport Management Quarterly, Vol. 11, No. 5, 495523, December 2011

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Corporate Governance and Earnings Management in the European Football Industry PANAGIOTIS DIMITROPOULOS Department of Sport Management, University of Peloponnese, Sparta, Greece

ABSTRACT The scope of this paper is to analyze the impact of corporate governance quality (namely board size, board independence, managerial ownership, institutional ownership and CEO duality) on the earnings management behaviour of European Union’s football clubs over the period 20062009. Empirical results documented that corporate governance quality mitigates aggressive earnings manipulation (income smoothing, accrual manipulation and reporting small positive income) by football managers and specifically clubs with increased board independence, managerial ownership and institutional ownership and small board size are associated with high quality financial reporting through the deterioration of earnings management behaviour. These findings dictate the necessity of sound corporate governance principles to protect the interests of shareholders and various stakeholders, and prevent the expropriation of wealth by managers and maximize the clubs’ economic results and social return. The empirical findings are robust to several sensitivity tests concerning the functioning form of the models and the measures of earnings management. KEYWORDS: Earnings management; earnings quality; corporate governance; football clubs; European Union

Corporate governance has evolved as a crucial issue not only for an enterprise’s function and control, but also for providing a degree of confidence for the proper functioning of the market economy (OECD, 2004). According to Tricker (1993) and de Barros, Barros, and Correia (2007), the main role of corporate governance is to ensure conformance by management and to enhance organizational performance through efficient board supervision of managers’ work.

Correspondence address: Panagiotis Dimitropoulos, Department of Sport Management, University of Peloponnese, Orthias Artemidos & Plataion, Sparta 23100, Greece. Email: [email protected] ISSN 1618-4742 Print/ISSN 1746-031X Online # 2011 European Association for Sport Management http://dx.doi.org/10.1080/16184742.2011.624108


496 Panagiotis Dimitropoulos Accordingly, the issue of efficient corporate governance in sport organizations was initially raised in 1997 by the Australian Standing Committee on Recreation and Sport. Similar reports were published in the UK and New Zealand and by respective federations and research centres and also by the International Olympic Committee. On that direction, Sport and Recreation New Zealand (2004) and Standards Australia (2003) have published a set of governance principles for sport organizations which among others declare that sport organizations must be accountable to shareholders and stakeholders and provide transparent and reliable information to all interested parties, internal and external. Despite the increased attention on efficient corporate governance practices by many sport associations and confederations across the world, the Football Governance Research Centre (2005) declared that there is a great deal of evidence to suggest that football clubs are not so effective in balancing the shareholder’s (and stakeholder’s) interests with those of the organization. This argument finds support by many recent cases of sports clubs’ financial mismanagement (e.g., lack of budgetary policy and enforcement, managerial instability and even fraudulent behaviour on behalf of some managers) which sometimes resulted in severe financial instability and mere insolvency (Rezende, Dalmacio, & Facure, 2010). Research by authors such as Bosca et al. (2008), Lago, Simmons, and Szymaski (2006), Ascari and Gagnepain (2006), Frick and Prinz (2006), Barros (2006), Rezende, Dalmacio, and Facure (2010) and Dimitropoulos (2009, 2010) indicate the size of the financial instability which characterizes football clubs and leagues across Europe. According to the UEFA (Union of European Football Associations) Executive Committee (2010), the issue of financial instability has created difficult market conditions for clubs in Europe and can negatively impact their revenue generation ability and even their future viability and going concern. This fact urged UEFA regulators to introduce the ‘‘Financial Fair Play’’ regulation, the scope of which was to introduce more discipline and rationality of clubs’ finances and generally to protect the long-term viability of European football clubs. It is believed that the above mentioned regulation will help alleviate the financial inconsistencies of many EU football clubs, yet there is no provision regarding the quality of corporate governance of the clubs and how it can impact the quality of published accounting information. So this fact makes the issue of clubs governance even more crucial under the new UEFA regulation. However, the relative research on sport governance is quite limited and is mainly focused on issues of pay-performance of sport managers (de Barros, Barros, & Correia, 2007), governance structure and organization, conflict of interests and accountability (Amara et al., 2005; Enjolras & Waldahl, 2010; Franck, 2010; Havaris & Danylchuk, 2007; Lee, 2008; Michie & Oughton, 2005; Sherry & Shilbury, 2009). Only two related Brazilian studies by Silva (2007) and Rezende, Dalmacio, and Facure (2010) argued that football clubs with improved mechanisms of corporate


Corporate Governance and Football

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governance are associated with incremental published information and the better the level of accounting disclosure the better their financial results. One aspect of the quality of accounting disclosure is the level of earnings management. The relative literature regarding the effect of efficient corporate governance mechanisms on mitigating aggressive earnings management behaviour is quite extensive (Armstrong, Guay, & Weber, 2010 provide a thorough review on this issue). Research by Yermack (1996), Weisbach (1988), Beasley (1996), Dechow, Sloan, and Sweeney (1996), Peasnell, Pope, and Young (2000), Klein (2002), Mishra, Randoy, and Jenssen (2001), Hsu and Koh (2005), Wang (2006), Leventis and Dimitropoulos (2010), and Dimitropoulos and Asteriou (2010) documented that firms with efficient corporate governance practices are less prone to accounting fraud and report accounting disclosures with enhanced quality and reliability. Nonetheless, the above mentioned studies are all focused on non-sport organizations or corporations, therefore the generalization of these findings within sport corporations remains an open empirical question. Franck (2010) argues that football clubs today have transformed into public companies and their functions are similar compared with those of regular profit-seeking corporations. Yet there are several peculiarities of football clubs relative to the other corporations (e.g., issues of balancing financial sustainability and athletic success, the specificities of the sport labour market and the characteristics of the sport product) that according to Michie and Oughton (2005) make the issue of good governance more and more important for football clubs. Also Barajas and Rodrı´guez (2010) question the quality of accounting information published by Spanish football clubs arguing that someone must be really conscious of this fact when analyzing the financial situation of football clubs. Thus, the issue of reliable and transparent accounting information has been raised by several researchers in Europe, despite the fact that the European football industry is perceived as more regulated and organized, as argued by Foster (2000). Additionally, there are some other reasons supporting the scope of this research and its contribution on the issue of governance quality as a mechanism for mitigating earnings management. The first originates from the important role of the financial reporting system as a provider of valuable and reliable information to outside directors, shareholders and stakeholders that aid the effective monitoring of inside management. The second reason refers to debt contracting and the role of financial reporting in reducing information asymmetries with existing and potential creditors (Watts, 2003). When football clubs need to negotiate the terms of debt capital, lenders demand the assurance that the firm is committed to providing accurate and timely information about its financial position. This issue is more critical for unlisted football clubs if someone considers that the money market (beyond internal equity or confederation funding) remains the last available source of financing. Also, according to Garcia-del-Barrio and Szymanski (2009), football clubs in the Spanish and English leagues tend to be more win maximizers than profit maximizers, a fact which may provide an additional motive to football managers to manipulate accounting numbers.


498 Panagiotis Dimitropoulos Finally, the issue of corporate governance quality may be of increased significance due to the new UEFA financial fair play regulation, which may create another form of pressure or motive for football managers to manipulate their financial statements to achieve their licensing by UEFA. Thus, under these circumstances, efficient corporate governance may be viewed as an additional ally to regulators’ efforts to achieve the financial stability and transparency of clubs. As Michie (2000) argued, there is an urgent need to consider alternative forms of ownership and governance for football clubs and the reason is because directors’ behaviour many times suggests that they are more interested in personal financial benefits or social status and less in the interests of their stakeholders. The empirical evidence of this study supports the argument that corporate governance quality mitigates aggressive earnings manipulation (income smoothing, accrual manipulation and reporting small positive income) by football managers, dictating the necessity of sound corporate governance principles for protecting the interests of shareholders and various stakeholders, to prevent the expropriation of wealth by managers and to maximize the clubs’ economic results and social return (Rezende, Dalmacio, & Facure, 2010). The rest of the paper is organized as follows: (a) a discussion of the relevant literature on the issue of governance quality and its impact on earnings management and statement of the main research hypotheses; (b) a description of the data used in the study and analyses and the methodological framework; (c) the empirical results and the sensitivity analysis; and (d) the main conclusions, policy implications and fruitful avenues for future research. Literature Review and Testable Hypotheses According to agency theory (Jensen & Meckling, 1976) the separation of ownership and control may create self-interested actions by the managers. In the case of such conflicts between managers and stakeholders the firm value is diminished and as Palliam and Shalhoub (2003) argued, this value minimization is attributed to agency costs. Many researchers in the past have provided evidence that managers have several incentives to manipulate accounting earnings, like the distribution of ownership (Hsu & Koh, 2005; Koh, 2003), the quality of the audit firm and effort (Caramanis & Lennox, 2008; Davidson et al., 2004; Leventis & Dimitropoulos, 2010), the existence of CEOs (Chief Executive Officers) with dual leadership positions (Davidson et al., 2004), managerial share ownership and equity compensation (Armstrong, Guay, & Weber, 2010; Bergstresser & Philippon, 2006) and even tax incentives (Dhaliwal, Gleason & Mills, 2004). Under these circumstances there is a need to monitor managers’ behaviour to protect stakeholders’ interests and shareholders’ rights. Shleifer and Vishny (1997) argued that corporate governance provides the framework for ensuring that suppliers of corporate finance will achieve a return on their investment. Previous studies on this field have provided


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significant evidence that the probability of earnings management is lower in companies with effective mechanisms of corporate governance (Agrawal & Chadha, 2005; Beasley, 1996; Demirkan & Platt, 2009; Dimitropoulos & Asteriou, 2010; Hutchinson, Percy, & Erkurtoglu, 2008; Klein, 2002; Peasnell, Pope, & Young, 2005; Vafeas, 2005). Also, a study by de Barros, Barros, and Correia (2007) documented the existence of principal-agent problems in Madeira sport clubs and argued that codes of governance must be employed so as to restrain the role of interest groups whose actions suit their own interests and deceive stakeholders. Therefore, we believe that football clubs which have established more effective governance mechanisms within the organization will provide better quality financial reports in terms of lower earnings manipulation.

Board Size The size of the board of directors has been considered extensively by empirical studies on the field of corporate governance as a significant mechanism that affects the quality of published accounting information. Yermack (1996) and Jensen (1993) argued that smaller boards are associated with higher market valuation, consistent with the idea that the benefits of increased monitoring by larger boards may be outweighed by poorer decision-making. Karamanou and Vafeas (2005) documented that updates of management earnings forecasts (which indicate lower accounting quality) are more probable in firms with larger boards. Similarly, Beasley (1996) documented that board size is positively associated with the incidence of financial statement fraud, and Ching, Firth, and Rui (2006) found a positive relationship between the degree of earnings management and the size of the board of directors in a sample of Hong Kong firms. Moreover, Certo, Daily, and Dalton (2001) reported that larger corporate boards are associated with lower under-pricing for IPOs, (Initial Public Offerings), and Chaganti and Mahajan (1985) argued that the appointment of several directors of various backgrounds within larger boards may help to avoid corporate failure. Also, Dimitropoulos and Asteriou (2010) provided evidence for a positive association between board size and earnings quality in the Greek capital market. On the contrary, Peasnell, Pope, and Young (2005) conducted similar research in the UK and found a negative association between earnings management and board size. Similar results were also reported by Vafeas (2000) and Ahmed, Hossain, and Adams (2006) and further corroborated by Iqbal and Strong (2010) in the UK’s capital market. In total, the empirical findings relative to the mitigating role of board size on earnings management are quite vague, with one group arguing that larger boards perform a more thorough control of managers’ decisions, while on the contrary other studies argue that smaller corporate boards are more efficient monitors than large boards because they have a higher level of membership coordination and communication efficiency and a lower incidence of intense free-rider problems (Dimitropoulos & Asteriou,

500 Panagiotis Dimitropoulos 2010). Based on the above discussion we form our first hypothesis as the following: H1: Board size is associated with the level of earnings management.


The Role of Outside Directors A large body of research provides significant evidence for a strong relation between board independence and earnings management (Klein, 2002). As Marnet (2008) argued, independent boards contribute towards the integrity of financial statements through the control of managerial conflict of interests. This argument has been verified empirically by Dechow, Sloan, and Sweeney (1996) and Beasley (1996), who documented that a higher proportion of outside directors on the board is associated with greater confidence in the firm’s financial reporting system. Also, an earlier study by Fama and Jensen (1983) argued that outside directors have incentives to effectively monitor managers’ behaviour in order to sustain their reputation as independent directors and also to signal to the market that they are acting according to the interests of shareholders. Agrawal and Chadha (2005) found that the probability of earnings manipulation is lower in companies with more independent boards, and Persons (2006) documented a negative association between board independence and non-financial reporting fraud. Moreover, Peasnell, Pope, and Young (2005) found that firms with a higher percentage of outside directors are less likely to manipulate income numbers to avoid reporting earnings decreases or losses. This finding is further corroborated by several international studies, such as Chen, Elder, and Hsieh (2007) in the Taiwanese capital market, Hutchinson, Percy, and Erkurtoglu (2008) in the Australian market, Iqbal and Strong (2010) in the UK market and Dimitropoulos and Asteriou (2010) in the Greek capital market, all of which documented a negative relation between the level of board independence and the use of absolute discretionary accruals as a tool for earnings management. In addition, in a related study by Garcia Osma (2008), is the Spanish capital market, there is evidence that a more independent board contributes towards restricting managers from using R&D (Research & Development) expenditure as a tool for earnings management. Therefore, all the aforementioned studies unanimously provide evidence of the mitigating role of board independence on the aggressive earnings management behaviour by firm managers. Based on the above evidence we formed our second hypothesis: H2: Board independence is negatively associated with the level of earnings management.

Managerial Ownership According to agency theory, when a firm is increasing its level of managerial share ownership it might reduce the conflict of interest between managers and shareholders, since the goals of these related parties are better aligned



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(Jensen & Meckling, 1976). This argument suggests that ownership in the company will ensure that managers will undertake strategies that will increase the value of the firm. This intuition has been verified by many studies in several developed capital markets. Warfield, Wild, and Wild (1995) documented that managerial ownership is inversely related to the magnitude of accrual adjustments (earnings management) and positively related to the information quality of earnings. Also Peasnell, Pope, and Young (2005) argued that the role of independent directors in mitigating aggressive earnings management exists only in firms with low managerial ownership. Corroborating evidence was also presented by Iqbal and Strong (2010) in the UK which argued that managers with a larger stake in the firm engage in less earnings manipulation. Referring to the European football industry, Peterson (2009) argued that the majority of football clubs in the major European football leagues are either completely controlled by a few shareholders (managers and institutions) or have a majority shareholder with more than 75% of voting rights. For instance, only three of the 38 German and English football clubs presented a dispersed ownership structure, including a majority shareholder with a stake lower than 30%. Therefore, taking into consideration the fact of increased managerial ownership of European football clubs and the empirical findings of a negative association between managerial ownership and earnings management behaviour, we formed our third hypothesis as follows: H3: Managerial ownership is negatively associated with the level of earnings management.

Institutional Ownership The importance of institutional shareholders for the credibility of the entire corporate governance system has been recognized by international organizations such as the (Organization for Economic Cooperation & Development) OECD (2004) and the Cadbury Committee (Cadbury, 1992). As Mallin (2008) argued, active institutional investors contribute towards the transparency of managerial decisions and the protection of shareholders’ interests. Empirical studies on this issue have verified the above-mentioned assumption by documenting a negative association between earnings management and institutional ownership. For instance, Rajgopal, Venkatachalam, and Jiambalvo (1999) found a negative relation between institutional share ownership and the absolute value of discretionary accruals. Also Bushee (1998) argued that when institutional ownership is high, managers are less likely to cut R&D investments in order to reverse an earnings decline. These findings have also been verified by Jiang and Anandarajan (2009) and Jalil and Rahman (2010) who found that institutional investors mitigate any aggressive earnings management behaviour and enhance the quality of published accounting information. The intuition for the aforementioned findings lies on the argument made by Hill and Jones (1992), who argued that when investors have a

502 Panagiotis Dimitropoulos


high stake in a firm (in the form of assets or shares) they will demand more comprehensive incentive mechanisms and governance structures so as to safeguard their investments (Senaux, 2008). Put another way, the higher the share of institutional investors in a firm, the higher the incentives for establishing sound principles of corporate governance. Considering the fact that European football clubs are characterized by high ownership concentration either from managers or institutions, we believe that the higher the institutional ownership in a club, the stronger the governance monitoring and the lower the incidence of earnings management. Therefore, we formulated the fourth hypothesis as follows: H4: Institutional ownership is negatively associated with the level of earnings management.

CEO Duality There is a long debate on whether the CEO should serve as the chairman of the board of directors. On the one hand, a dual role of the CEO may enhance a firm’s financial performance since the CEO has a thorough knowledge of the strategies and the operations of the firm. Conversely, when corporate insiders are absent from a majority independent board then the directors depend heavily on the CEO for inside information (Chang & Sun, 2010). As Mitchell (2005) argued, critical information is often hidden from the directors (or even falsified) and so the CEO may influence the decisions of the board. So, under this framework several studies have empirically tested the link between earnings quality and the duality of the CEOs. Kim and Nofsinger (2004) argued that despite the fact that in many US firms the CEO also chairs the board, the separation of these two positions provides greater independence to the board, declaring that outside directors may not be enough to sustain board independence. Earlier studies by Yermack (1996) and Jensen (1993) argued that combining the responsibilities of the CEO and the chairman in one individual has monitoring implications. Klein (2002) documented that when boards are independent from the CEO, they are better able to perform their monitoring role and to mitigate any earnings management behaviour from the top management. Additionally, Anderson et al. (2003) document that the quality of earnings is positively related to firms with separate CEO and chairman positions. Gul and Wah (2002) argued that firms with dual-role CEOs are more likely to manipulate discretionary accruals especially when the managerial ownership exceeds 25%. These results are further corroborated by Dey (2008) and Chang and Sun (2009, 2010). Consequently, all the aforementioned studies document a positive association between earnings quality and the separation of the CEO and board chairman roles. Following the previous discussion we formed the fifth and final hypothesis in the alternate form: H5: There is a positive association between earnings management and CEO duality.


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Data and Research Design


Data Selection Procedure The research sample includes data from 67 football clubs (7 listed and 60 unlisted) from 10 European Union (EU) countries namely Belgium, Denmark, France, Germany, Italy, Netherlands, Sweden, Spain, Greece and UK for the period 20062009, summing up to 268 firm-year observations. Our initial sample included 79 football clubs but we removed those which did not provide complete accounting and governance data for every year between 2006 and 2009, thus limiting the final number to 67 clubs. The main criteria that each club had to fulfil to be included in the sample was to have full financial data published in their annual financial statements (audited by a certified chartered accountant), provide details on corporate governance (mainly board and ownership structure) and to close their fiscal year in June. Specifically, we extracted data regarding clubs’ net income, total assets, shareholders’ equity, net sales, total debt and cash flows. The research sample is restricted only to clubs participating within the elite division of each country’s official championship for all years under investigation. The reasons are that we wanted to mitigate any biases arising from the relegation of football clubs to lower divisions and because clubs in the elite division attract greater publicity, have increased chances for external financing and their financial statements provide greater reliability since they are permanently audited by certified chartered accountants. Also clubs in the elite divisions are highly capitalized, are in the forefront of the national championships and due to their frequent participation in the UEFA competitions, they attract the interest of the public, regulators, fans, investors and other stakeholders. All data were hand collected from each club’s annual reports and no further trimming was conducted since we did not want to lose observations and induce bias in the final outcome. Research Design Our research design includes the estimation of three different measures of earnings management. The first measure identifies positive earnings as a common target of earnings management. This idea of earnings management detection was first introduced by Hayn (1995) who documented that there is an increased regularity of corporations which publish small positive earnings, yet there are less firms reporting small losses (below the zero point). The frequency of observations lying above or below the zero-point was found to be deviating significantly from the expected frequency of the normal distribution at the 1% level. This finding indicates that managers of firms with actual earnings below the zero-point use earnings management techniques so as to avoid reporting losses or negative changes in the profit stream from one fiscal year to another. The reason for this behaviour is mainly psychological and aims at influencing market participants (investors) and banking institutions. Burgstahler and Dichev (1997), Leuz, Nanda, and Wysocki (2003), and Barth, Landsman, and Lang (2008) use the frequency


504 Panagiotis Dimitropoulos of small positive net income as a metric of managing towards positive earnings. The underlying notion is that managers make every possible effort to report small positive net income rather than negative net income. Consequently, we expect football clubs with efficient corporate governance quality to report small positive net income less frequently. In order to test this assertion we followed Burgstahler and Dichev (1997) and Barth, Landsman, and Lang (2008) and estimated an indicator variable SPOS that equals ‘‘1’’ if net income deflated by lagged total assets is between 0 and 0.01 for each given year and ‘‘0’’ otherwise. Burgstahler and Dichev (1997) examined the SPOS range between 0 and 0.01 for non financial corporations. They explained the specific SPOS range due to asymmetric distribution around the 0.01 level. We plot our earnings data for the range 0.5 to 0.5 in a histogram. The figures showed a single-peaked, bell-shaped distribution with an irregularity near zero. We followed Burgstahler and Dichev (1997) arguing that this practice is consistent with discretion to avoid earnings decreases. Earnings greater than zero occur more frequently than it would be expected and they are gathered within the interval (0.000.013). We assumed that in the absence of earnings management the distribution of earnings will be symmetric (around 0.01) and the right half of distribution would be unaffected by earnings management, similar to Burgstahler and Dichev (1997). The specific procedure yield a significant t-statistic (t11.225, pB0.001) indicating discontinuity of the distribution around zero, suggesting that football managers use discretion for avoiding earnings decreases. After estimating this dichotomous variable, we introduced it as the dependent variable in the following logit regression model: SPOSit ¼ a0 þ a1 BINDit þ a2 BDSIZEit þ a3 MOWNit þ a4 IOWNit þ a5 CEODUALit þ bControlsit þcYear dummies þ dCountry dummies þ eit

(1)

Where, BIND indicates board independence estimated as the ratio of independent directors to the total number of directors on the board. Independent directors are defined as (a) those who are not an active or retired employee of the firm, (b) do not have any close business ties and (c) are not representatives of a major shareholder of the firm (Ahmed, Hossain, & Adams, 2006; Hossain, Cahan, & Adams, 2000). Therefore if H2 is valid we expect to find a negative and significant coefficient on this variable suggesting that football clubs with increased board independence report small positive net income less frequently or, put another way, are characterized by more reliable accounting information. BDSIZE is the total number of directors serving on the board at the end of the fiscal year (Iqbal & Strong, 2010; Peasnell, Pope, & Young, 2005) and captures board size. MOWN is the level of managerial ownership estimated as the percentage of share capital owned by the directors of each football club at the end of the fiscal year (Iqbal & Strong, 2010). IOWN is the



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level of institutional ownership estimated as the percentage of share capital owned by institutional investors of each football club at the end of the fiscal year (Iqbal & Strong, 2010; Koh, 2003). Since empirical findings relative to the mitigating role of board size are quite vague we expected the coefficient on the BDSIZE variable to be significant (validating H1) but we cannot infer any projections about the sign of those coefficients. Conversely, if H3 and H4 are confirmed the relative coefficients on the MOWN and IOWN variables are expected to be negative and significant. Our last corporate governance variable is CEODUAL which captures the dual role of the CEO as the chairman of the board. It is a dichotomous variable coded as a ‘‘1’’ if the CEO is also the board’s chairman and ‘‘0’’ otherwise. According to H5 we expected to find a positive coefficient on this variable suggesting that the separation of the CEO and chairman positions may result in less earnings manipulation and improved financial reporting quality. In all models we included several control variables that have been shown to be significant determinants of accounting quality in previous research and also because we wanted to capture differences in earnings management incentives. First of all we controlled for a football club’s size measured as the natural logarithm of total assets (LnTA) at the end of the fiscal year. As Watts and Zimmerman (1990) and Van Tendeloo and Vanstraelen (2005) argued, larger firms are more likely to prefer downward earnings management because the potential for regulatory scrutiny increases as firms are larger and more profitable. Therefore, we expect a negative relation between the SIZE variable and the tendency to report small positive income (or alternatively to avoid earnings decreases). Also we controlled for football clubs’ growth prospects (GR) measured as the percentage change in sales from year t 1 to year t. Lee, Li, and Yu (2006) demonstrated that higher growth firms are more likely to manipulate earnings. Also Abarbanell and Lehavy (2003) argued that firms with higher growth opportunities have stronger incentives to meet or beat analysts’ earnings forecasts. This argument is verified by many studies, including Clinch (1991), Gaver and Gaver (1993), Ittner, Lambert, and Larcker (2002), and Iyengar, Land, and Zampelli (2010). Consequently, we predict football clubs with increased growth prospects manipulate accounting numbers more frequently and so the GR coefficient is expected to be positive. Additionally, we controlled for the impact of firm leverage (LEV). Van Tendeloo and Vanstraelen (2005) and Billings (1999) documented that the debt-equity hypothesis predicts that high leveraged firms are more likely to engage in upward earnings management to avoid debt covenant violations. Also Iqbal and Strong (2010) argued that managers may be tempted to inflate reporting earnings (or avoid reporting a loss) in order to increase the ability of servicing existing debt (through more debt financing). This behaviour is also quite common in European football clubs (Garcia-delBarrio & Szymanski, 2009) which are more win maximizers than profit maximizers and are willing to sustain severe losses for enhancing their on-field performance. Therefore, we believe that leverage (as measured by the ratio of total debt to common equity) will have a positive relation


506 Panagiotis Dimitropoulos with earnings management and the tendency to report small positive income. Also, we include the level of operating cash flows deflated by lagged total assets as a performance measure. Dimitropoulos and Asteriou (2009) documented that cash flows provide significant information regarding the quality of published accounting information. Iqbal and Strong (2010) documented a negative association between cash flows and earnings management in the UK’s capital market suggesting that firms with increased operating cash flows have less incentives to manipulate accounting numbers through accruals. Consequently, we expected a negative coefficient on the CFO (Operating Cash Flows) variable. Moreover, we controlled for effect of external audit quality by including a dummy variable (AUDQ), receiving ‘‘1’’ if a football club is audited by a big4 multinational audit firm and ‘‘0’’ otherwise. Clubs audited by big-4 audit firms are expected to report financial statements of enhanced quality, thus are less subject to earnings management (Ghosh & Moon, 2005; Gul, Sun, & Tsui, 2003; Gul, Tsui, Dhaliwal, 2006; Park & Pincus, 2001; Teoh & Wong, 1993). The reason is that big-4 audit firms have more incentives to implement a more transparent financial reporting policy, since any disclosure of false audit reports or misjudgement could cause a severe strike on auditors’ reputations. Consequently we expect a negative coefficient on this variable. Our last control variable captures the different earnings management incentives between publicly listed and unlisted football clubs. DLIST is a dichotomous variable receiving ‘‘1’’ if a football club is listed on the stock market and ‘‘0’’ otherwise. As Nichols, Wahlen, and Wieland (2009) argued, the incentives for earnings manipulation differ between listed and unlisted firms. Specifically, when a firm’s appetite for equity capital from external investors grows so does the need to meet earnings expectations, and so managers face the ability and the expanded incentive to exercise income increasing accounting. Therefore, we expect listed football clubs to have greater incentives to manipulate accounting numbers and repost small positive income more frequently relative to unlisted football clubs. Thus, the coefficient on the DLIST variable is expected to have a positive sign. Our second measure of earnings management aims at examining the impact of corporate governance quality on the magnitude of performancematched discretionary accruals. The term ‘‘accruals’’ originates from the accrual basis of accounting (prescribed by the majority accounting regulations internationally and by the UEFA financial fair play regulation) which dictates that all expenses and revenues that have been incurred but not yet paid or received must be reported within the financial statements. Accruals are estimated as the difference between net income and operating cash flows and the base of earnings manipulation is actually evidenced in the use of accruals in such a manner where private benefits may be extracted for corporate managers. Further, accruals are sub-divided into normal (or nondiscretionary accruals) and discretionary accruals based on their nature and origin. Normal accruals are attributed mainly to adjustments on cash flows due to accounting rules and regulations, while on the contrary discretionary



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accruals are those where the level is adjusted or manipulated by the managers according to disclosure decisions made explicitly by them. Some classic examples of discretionary accruals used by managers to manipulate their financial statements are the disclosure of increased depreciation and amortization expenses prior to initial public offerings, increasing bad debt provisions and disclosing increased provisions for deferred taxation. The most popular empirical model for estimating normal and discretionary accruals was proposed by Jones (1991), the scope of which is to distinguish the factors that affect the firm’s level of normal accruals. For this reason in this study we estimated the cross-sectional Jones (1991) model, as being modified by Kothari, Leone, and Wasley (2005), in order to extract the discretionary or abnormal accruals following a performance matching approach. This model estimates discretionary accruals as a function of changes in sales, the level of property, plant and equipment and the level of return on assets by estimating the following OLS (Ordinary Least Squares) equation: ACCit =TAt1 ¼ a0 þ að1=TAt1 Þ þ bðDSalesit =TAt1 Þ þ cðPPEit =TAt1 Þ þ gROAit þ eit

ð2aÞ

Where, ACCit is total accruals defined as the difference between net income and operating cash flows divided by lagged total assets. DSalesit is the change in net sales deflated by lagged total assets (Salesit Salesit 1). PPEit is the level of property plant and equipment for each year deflated by lagged total assets. ROA is the end of year return on assets estimated as net income over total assets. TAit is firm’s total assets at the end of the fiscal year. As Kothari, Leone, and Wasley (2005) argued, the inclusion of a constant term in the Jones (1991) model provides an additional control for heteroscedasticity not improved by deflating the variables with total assets. Also, including a constant term mitigates problems arising from the omitted size variable and produces discretionary accrual measures that are more symmetric, making the power of the test comparisons more clear and overcoming model misspecifications. Finally, the inclusion of a profitability measure (ROA) is designed to increase the effectiveness of the performance matching methodology. The discretionary accruals from the modified Jones (1991) model are defined as the residuals from estimating equation (2a): ^ ^ DACit ¼ ACCit =TAit1 að1=TA it1 Þ þ bðDSALESit =TAit1 Þ ^ ^ þ cðPPE it =TAit1 Þ þ gROA

(2b)

In order to estimate the performance-matched discretionary accruals we followed Kothari, Leone, and Wasley (2005) and matched each football


508 Panagiotis Dimitropoulos club’s year observation with another from the same year, with the closest return on assets (ROA). The final step is to define the Jones-model performance-matched discretionary accruals for club i in year t as the discretionary accruals from equation (2b) minus the matched firm’s Jonesmodel discretionary accruals for year t. As Kothari, Leone, and Wasley (2005) argued, the performance matching approach based on ROA and using the Jones model produces a more salient measure of discretionary accruals since the means and medians in performance-related sub samples are closest to zero more often than the other measures. The absolute value of performance-matched discretionary accruals (jDACCj) from Equation 2b is our second measure of earnings management. The absolute value is used because earnings management can involve either income increasing or income decreasing accruals to meet earnings targets (Bowen, Rajgopal, & Venkatachalam, 2003; Klein, 2002; Reynolds & Francis, 2000; Wang, 2006; Warfield, Wild, & Wild, 1995). A higher value indicates a greater level of manipulation in the financial statements, thus lower earnings quality. In order to test our research hypotheses we introduced the absolute value of performance-matched discretionary accruals jDACCj as the dependent variable in the following model: jDACCit j ¼ a0 þ a1 BINDit þ a2 BDSIZEit þ a3 MOWNit þ a4 IOWNit þ a5 CEODUALit þ bControlsit þ cYear dummies þ dCountry dummies þ eit

(3)

The corporate governance and the control variables were defined as in Equation 1. According to our main research hypotheses we expected coefficients a1, a3 and a4 to have negative signs, while coefficient a5 is expected to be positive and significant and a2 to be statistically significant. We have also included in both Equations 1 and 3 country dummies in order to encapsulate any unobservable country-specific effects and year dummies to capture timespecific effects and also to deal with the problem of heteroscedasticity in the error term. The last measure of earnings manipulation is based on the most commonly used practice of earnings management, which is income smoothing. Income smoothing refers to the decrease of profit stream variance which indicates the level of business risk. Investors, according to Barth, Landsman, and Lang (2008), believe that published profits are more reliable when their expected level is closer to their actual level. A large deviation of actual profits from the expected profits decreases their reliability and further erodes corporate value. So, firm managers may be motivated to reduce the variance of their profit stream in order to moderate the perceived firm risk. A commonly used measure of income smoothing which will be implemented in this study is the Spearman correlation between accruals and cash flows between football clubs of high and low (above and below the median value respectively for every given year) board size, board independence, managerial ownership and institutional ownership, and the existence of CEO duality


509

(Leuz, Nanda, & Wysocki, 2003). In order to capture any confounding effects of factors that are not attributable to the financial reporting setting, we adopted the methodology proposed by Barth, Landsman, and Lang (2008) and compared the correlations of the accruals’ and cash flows’ residuals (CF* and ACC*) from the following regression models, instead of comparing the correlations between accruals and cash flows directly. The relative models have the following form:


CFit ¼ a0 þ a1 SIZEit þ a2 GRit þ a3 LEVit þ a4 AUDQit þ a5 DLISTit þ eit (4) ACCit ¼ a0 þ a1 SIZEit þ a2 GRit þ a3 LEVit þ a4 AUDQit þ a5 DLISTit þ eit (5) Where, CF is the annual operating cash flow divided by lagged total assets. ACC is total accruals measured as the difference between net income and CF divided by lagged total assets. SIZE is the natural logarithm of end year total assets. GR is the percentage change in sales. LEV is the ratio of end of year total liabilities to end of year total common equity. AUD is a dummy receiving (1) if the firm is audited by PwC, KPMG, Arthur Andersen, E&Y or D&T, and (0) otherwise. DLIST is a dummy receiving (1) for publicly listed football clubs and (0) otherwise. Barth, Landsman, and Lang (2008) interpreted a more negative correlation between accruals and cash flows as earning smoothing due to the fact that managers respond to poor cash flow outcomes by increasing accruals (through the increase of net income since accruals are the difference between net income and operating cash flows). If this is true we predict that football clubs with increased board independence, higher managerial and institutional ownership and separate roles between the chairman of the board and the CEO will present a less negative correlation between accruals and cash flows residuals. Results Descriptive Statistics and Correlations Table 1 presents the descriptive statistics of the sample variables for the whole period of investigation (20062009). As we can see, the absolute value of discretionary accruals is quite high, reaching 48% of average total assets, and almost 14% of the sample clubs have reported small positive income ranging between 0 and 0.01. Referring to the governance variables, the mean board has nine members, almost half of which (46.6%) are

510 Panagiotis Dimitropoulos


Table 1.

Descriptive statistics of sample variables (20062009).

Variables

Mean

Median

St. deviation

Minimum

Maximum

jDACCj SPOS BDSIZE BIND MOWN IOWN CEODUAL SIZE GR LEV CFO AUDQ DLIST

0.4841 0.1373 9.493 0.4661 0.4744 0.4899 0.9254 8.268 0.378 1.107 0.1898 0.1642 0.1044

0.2288 0.0000 8.0000 0.4000 0.5200 0.4200 1.0000 8.262 0.075 0.833 0.0619 0.0000 0.0000

1.4735 0.1899 7.157 0.2340 0.3962 0.4040 0.2633 1.768 1.892 2.113 1.5070 0.3711 0.2374

0.0003 0.0000 3.000 0.1000 0.0000 0.0000 0.0000 3.963 0.932 0.052 5.7436 0.0000 0.0000

22.5404 1.0000 33.000 0.9000 1.0000 1.0000 1.0000 12.982 22.498 31.159 20.685 1.0000 1.0000

Notes: The sample includes data from 67 football clubs from 10 EU countries over the period 20062009. Seven clubs are publicly listed and 60 unlisted. jDACCj is the absolute value of performance-matched discretionary accruals estimated from the Jones (1991) model as modified by Kothari, Leone, and Wasley (2005), SPOS is an indicator variable receiving (1) if a club’s net income over lagged total assets lies between 0 and 0.01 for a given year and (0) otherwise, BDSIZE is the total number of directors serving on the board, BIND is the ratio of independent directors to the total number of directors serving on the board, MOWN is the percentage of shares owned by the directors, IOWN is the percentage of shares owned by institutional investors, CEODUAL receives (1) if the CEO is also the chairman of the board and (0) otherwise, SIZE is the natural logarithm of total assets at the end of the fiscal year, GR is the annual percentage change in sales, LEV is the ratio of total debt to common equity, CFO is the ratio of cash flows to lagged total assets, AUDQ receives (1) if the club is audited by a big-4 audit corporation and (0) otherwise, DLIST is a dummy receiving (1) if a club is publicly listed and (0) otherwise.

independent. Therefore, football clubs in our sample have adequate levels of board independence. On the contrary, the CEO of the football club has a dual role as the chairman of the board in 93% of the sample clubs. Also, directors hold 47% of club’s share capital while 49% is held by institutional investors. Finally, concerning the rest of the control variables we can argue that football clubs in our sample are highly leveraged, have adequate growth opportunities, tend to generate low levels of operating cash flows and have low audit quality since only 16% of them is being audited by a big-4 audit corporation. Table 2 presents the Pearson correlation coefficients among the sample variables for the period of investigation (20062009). The absolute value of discretionary accruals is negatively correlated with board independence ( 0.128), a result which provides some initial support to our second hypothesis suggesting that increased board independence results in lower levels of accruals and enhanced earnings quality. Discretionary accruals are also negatively correlated with operating cash flows ( 0.694) as expected, indicating the negative association between cash flows and accruals

Variables

jDACCj

BDSIZE

BIND

MOWN

IOWN

CEODUAL

AUDQ

SIZE

GR

LEV

SPOS

CFO

BDSIZE BIND MOWN IOWN CEODUAL AUDQ SIZE GR LEV SPOS CFO DLIST

0.059 0.128 0.044 0.053 0.000 0.032 0.203 0.036 0.171 0.002 0.694 0.040

0.057 0.138 0.153 0.083 0.036 0.198 0.089 0.049 0.102 0.006 0.141

0.088 0.051 0.114 0.100 0.288 0.055 0.050 0.095 0.047 0.230

0.641 0.121 0.204 0.281 0.036 0.089 0.048 0.027 0.046

0.142 0.199 0.179 0.050 0.100 0.062 0.025 0.005

0.027 0.048 0.047 0.034 0.019 0.012 0.072

0.148 0.044 0.021 0.019 0.007 0.228

0.024 0.203 0.097 0.009 0.321

0.033 0.038 0.009 0.028

0.041 0.215 0.049

0.017 0.033

0.027

Notes: Coefficients in bold indicate statistical significance at the 5% level or more (two-tailed test). The sample includes data from 67 football clubs from 10 EU countries over the period 20062009. Seven clubs are publicly listed and 60 unlisted. jDACCj is the absolute value of performancematched discretionary accruals estimated from the Jones (1991) model as modified by Kothari et al. (2005), SPOS is an indicator variable receiving (1) if a club’s net income over lagged total assets lies between 0 and 0.01 for a given year and (0) otherwise, BDSIZE is the total number of directors serving on the board, BIND is the ratio of independent directors to the total number of directors serving on the board, MOWN is the percentage of shares owned by the directors, IOWN is the percentage of shares owned by institutional investors, CEODUAL receives (1) if the CEO is also the chairman of the board and (0) otherwise, SIZE is the natural logarithm of total assets at the end of the fiscal year, GR is the annual percentage change in sales, LEV is the ratio of total debt to common equity, CFO is the ratio of cash flows to lagged total assets, AUDQ receives (1) if the club is audited by a big-4 audit corporation and (0) otherwise, DLIST is a dummy receiving (1) if a club is publicly listed and (0) otherwise.



Table 2. Pearson correlation coefficients of sample variables (20062009).

511

512 Panagiotis Dimitropoulos (Dechow, 1994). Also, big clubs with large operating cash flows seem to manipulate their accrual numbers less frequently. On the contrary, highly leveraged clubs tend to engage in more aggressive earnings management. Additionally, clubs with larger boards tend to report small positive income more frequently, suggesting that small sized boards perform a better monitoring role compared to larger boards. Finally, listed football clubs are characterized by larger boards, greater board independence and audit quality compared to their unlisted counterparts.


Empirical Results for Earnings Management Table 3 presents the logistic regression results from the estimation of model 1, which captures the possibility that football managers exercise discretion in order to avoid reporting losses. As shown, the relationship between the dependent variable and the independent variables is statistically significant (x2 28.114, pB0.005). Also, the association strength between the dependent and the independent variables is R2L 21.5%, indicating a medium efficient strong relationship. The results indicate that corporate governance quality is an important mechanism which mitigates earnings management behaviour. More specifically, the level of board independence negatively impacts the probability of reporting small positive income by football managers ( 1.120 significant at the 5% level). Also, the levels of managerial and institutional ownership have a negative impact on the tendency to report small positive income since both coefficients are negative and significant at the 5% level. This evidence verifies hypotheses H2, H3 and H4 and corroborates previous evidence by Iqbal and Strong (2010), Iyengar, Land, and Zampelli (2010), and Jiang and Anandarajan (2009). Referring to the other governance variables, the CEO duality dummy has a positive sign as expected but it is not statistically significant. Thus, we cannot accept H5 within conventional levels. As for the size of the board, the relative coefficient was found positive and significant (0.077) suggesting that larger boards are more likely to perform income increasing earnings management, verifying past arguments by Beasley (1996), who documented that board size is positively associated with the incidence of financial statement fraud, Ching, Firth, and Rui (2006), who found a positive relationship between the degree of earnings management and the size of the board of directors, and Dimitropoulos and Asteriou (2010), who argued that smaller boards are associated with higher accounting reporting quality. Regarding the control variables, the SIZE of the clubs has a negative and significant coefficient as expected, suggesting that larger football clubs engage less in earnings management so as to avoid reporting losses. Also, football clubs with increased audit quality (big-4 audit firms) report small positive income less frequently since those multinational corporations have more incentives to implement a more transparent financial reporting process than local audit firms. The DLIST dummy has a positive sign as expected but is not significant within conventional levels. Finally, highly leveraged clubs tend to report small positive income more frequently as the sign of

Corporate Governance and Football Table 3.


Variables

513

Logistic regression results on reporting small positive income. Coefficient

Significance

Constant BIND BDSIZE MOWN IOWN CEODUAL SIZE GR LEV CFO AUDQ DLIST

4.358 1.120 0.077 2.649 2.217 0.025 0.636 0.288 1.385 0.152 0.488 1.331

0.253 0.050** 0.058** 0.065** 0.012* 0.844 0.048** 0.683 0.016* 0.796 0.066** 0.405

x2 R2L Year and country dummies

28.114 21.5% Included

0.005*

Notes: *, ** indicate statistical significance at the 1% and 5% level respectively (p-value with two tailed test).

SPOSit ¼ a0 þ a1 BINDit þ a2 BDSIZEit þ a3 MOWNit þ a4 IOWNit þ a5 CEODUALit þ bControlsit þ cYear dummies þ dCountry dummies þ eit

(1)

The dependent variable SPOS is an indicator variable receiving (1) if a club’s net income over lagged total assets lies between 0 and 0.01 for a given year and (0) otherwise, BIND is the ratio of independent directors to the total number of directors serving on the board, BDSIZE is the total number of directors serving on the board, MOWN is the percentage of shares owned by the directors, IOWN is the percentage of shares owned by institutional investors, CEODUAL receives (1) if the CEO is also the chairman of the board and (0) otherwise, SIZE is the natural logarithm of total assets at the end of the fiscal year, GR is the annual percentage change in sales, LEV is the ratio of total debt to common equity, CFO is the ratio of cash flows to lagged total assets, AUDQ receives (1) if the club is audited by a big-4 audit corporation and (0) otherwise, DLIST is a dummy receiving (1) if a club is publicly listed and (0) otherwise.

the coefficient suggests, thus verifying arguments by Van Tendeloo and Vanstraelen (2005), Billings (1999), and Iqbal and Strong (2010), who documented that highly leveraged firms are more likely to engage in upward earnings management. Table 4 presents the empirical findings from the estimation of model 3 which includes the absolute value of the performance matched discretionary accruals as the dependent variable. The regression F-statistic is highly significant (78.29) and the model’s explanatory power is also relatively high and up to 77.6%. Referring to the governance variables, all have the predicted sign and the significance is comparable to the results presented in Table 3. Specifically, the higher the independence of the board of directors

514 Panagiotis Dimitropoulos Table 4. Regression results on earnings management using discretionary accruals.


Variables Constant BIND BDSIZE MOWN IOWN CEODUAL SIZE GR LEV CFO AUDQ DLIST Regression F-stat Adjusted R2 Year and country dummies

Coefficient

t-statistic

0.622 0.190 0.004 0.156 0.114 0.048 0.064 0.039 0.224 0.835 0.105 0.222

1.54 1.91** 1.83** 2.11** 1.82** 0.28 1.95** 1.72** 10.41* 28.56* 1.86** 1.06

78.29* 77.6% Included

Notes: *, ** indicate statistical significance at the 1% and 5% level respectively (White, 1980, t-statistics with two tailed test).

jDACCit j ¼ a0 þ a1 BINDit þ a2 BDSIZEit þ a3 MOWNit þ a4 IOWNit þ a5 CEODUALit þbControlsit þ cYear dummies þ dCountry dummies þ eit

(3)

jDACCj is the absolute value of performance-matched discretionary accruals estimated from the Jones (1991) model as modified by Kothari, Leone, and Wasley (2005), BIND is the ratio of independent directors to the total number of directors serving on the board, BDSIZE is the total number of directors serving on the board, MOWN is the percentage of shares owned by the directors, IOWN is the percentage of shares owned by institutional investors, CEODUAL receives (1) if the CEO is also the chairman of the board and (0) otherwise, SIZE is the natural logarithm of total assets at the end of the fiscal year, GR is the annual percentage change in sales, LEV is the ratio of total debt to common equity, CFO is the ratio of cash flows to lagged total assets, AUDQ receives (1) if the club is audited by a big-4 audit corporation and (0) otherwise, DLIST is a dummy receiving (1) if a club is publicly listed and (0) otherwise.

( 0.190) and the level of managerial ( 0.156) and institutional ownership ( 0.114), the lower the absolute value of performance matched discretionary accruals, meaning that football clubs with these characteristics are associated with a higher quality of accounting earnings, thus verifying hypotheses H2, H3 and H4. Board size has a positive and significant coefficient verifying H1 and indicates that clubs with larger boards tend to engage in more aggressive earnings management via accrual manipulation. The CEO duality also has a positive yet insignificant impact on discretionary accruals, thus the separation of the roles of the CEO and the chairman of the board does not provide any assistance on mitigating aggressive earnings management. Finally, the control variables have the expected sign and the



515

majority of them are statistically significant, except the DLIST variable which is positive (as expected) but insignificant. In brief, football clubs with more total assets (size), increased operating cash flows and improved audit quality are associated with lower levels of performance matched discretionary accruals. Conversely, clubs with higher growth opportunities and leverage tend to report earnings of lower quality (higher level of discretionary accruals). The last test on earnings manipulation is based on the Spearman correlation between accruals and cash flows residuals (extracted from the estimation of models 4 and 5) between football clubs of high and low (above and below the median value respectively for every given year) board size, board independence, managerial ownership and institutional ownership, and the existence of CEO duality (Leuz, Nanda, & Wysocki, 2003). Barth, Landsman, and Lang (2008) interpreted a more negative correlation between accruals and cash flows as earning smoothing due to the fact that managers respond to poor cash flow outcomes by increasing accruals. The relative results are presented in Table 5. As shown, clubs with high board independence, managerial and institutional ownership present a smaller correlation coefficient ( 0.316, 0.489 and 0.371 respectively) compared to their lower counterparts. This result verifies evidence in Tables 3 and 4 suggesting that higher board independence, managerial and institutional ownership in football clubs mitigate income smoothing behaviour by managers. Also, the Spearman coefficient of clubs with above median level of board size is higher ( 0.560) relative to clubs with smaller boards (0.533), a finding which is also comparable with the evidence in the previous two tables. Thus, we can argue that smaller boards of football clubs tend to perform a more efficient role in mitigating income smoothing behaviour. Surprisingly, the separation of CEO and board chairman roles seems to be significant in mitigating income smoothing behaviour, since the correlation coefficient for football clubs with separate CEO/chairman roles is smaller ( 0.387) compared to clubs with CEO/chairman dual roles ( 0.543). Consequently, we can partially accept H5 and argue that the separation of these significant positions is within shareholders’ interests (Habib & Azim, 2008). Sensitivity Analysis In order to examine the robustness of our results, we performed several sensitivity tests related to the specification of the empirical models and the research design used in the study (results are untabulated but can be provided by the author upon request). First we re-estimated models 1 and 3 including additional interaction variables between the DLIST dummy and the governance variables in order to control for any effects of listed clubs that are not picked up by the sole control variable. Results remained qualitatively unchanged compared to those reported in Tables 3 and 4 since the interaction variables were insignificant within conventional levels. Also, we replaced the absolute value of discretionary accruals as the dependent

516 Panagiotis Dimitropoulos Table 5.

Spearman correlation coefficients between accruals and cash flows residuals.

Variables BIND BDSIZE MOWN


IOWN

Spearman correlations CFO*-ACC* Spearman correlations CFO*-ACC* Spearman correlations CFO*-ACC* Spearman correlations CFO*-ACC*

Spearman correlations CFO*-ACC*

Low

High

0.535*

0.316*

0.533*

0.560*

0.521*

0.489*

0.543*

0.371*

CEO/chairman dual roles 0.541*

CEO/chairman separate roles 0.387*

Notes: * indicates statistical significance at the 1% level (two-tailed test). CFO*, ACC*, are the accruals and cash flows residuals from the following two regression models:

CFit ¼ a0 þ a1 SIZEit þ a2 GRit þ a3 LEVit þ a4 AUDQit þ a5 DLISTit þ eit (4) ACCit ¼ a0 þ a1 SIZEit þ a2 GRit þ a3 LEVit þ a4 AUDQit þ a5 DLISTit þ eit (5) We have separated football clubs in our sample into two groups for low and high governance variables for every year if these are respectively below or above their median value. As for CEO duality we separated clubs into those with separate roles or dual roles for every sample year. BIND is the ratio of independent directors to the total number of directors serving on the board, BDSIZE is the total number of directors serving on the board, MOWN is the percentage of shares owned by the directors, IOWN is the percentage of shares owned by institutional investors, CEODUAL receives (1) if the CEO is also the chairman of the board and (0) otherwise, ACC is total accruals estimated as the difference between net income and operating cash flows deflated by lagged total assets, CF is the cash flow from operating activities deflated by lagged total assets, SIZE is the natural logarithm of end-year total assets capturing firm size, LEV is the leverage ratio estimated as total debt to common equity capturing systematic risk, GR is the annual percentage change of sales capturing growth opportunities, AUDQ is a dummy variable capturing audit quality, receiving (1) if the firm is audited by any of the big-4 audit corporations and (0) otherwise, and DLIST is a dummy receiving (1) for publicly listed football clubs and (0) otherwise.

variable in model (3) with total accruals in order to capture any problems from possible accrual misspecification arising from the estimation of the Jones (1991) model. The results remained unchanged after this modification. Moreover, we controlled for possible misspecification on the estimation of the performance-matched discretionary accruals. For this reason we followed Kothari, Leone, and Wasley (2005) and we re-estimated the Jones (1991) model: (a) without a constant, and (b) without matching firms based on ROA but estimating DACC including ROA as an additional regressor. The results are consistent with those reported in Table 4. Additionally,



517

we re-estimated the Spearman correlation coefficients between clubs with above and below median values of the main governance variables using the accruals and cash flows directly instead of using the residuals of these variables. The results are qualitatively similar with those in Table 5 with the only exception evidenced in the CEO/chairman dual role separation where the relative coefficient was statistically insignificant. We also performed our empirical tests after curtailing the 1% and 2% of the higher and lower ends of our observations so as to mitigate the effects of outliers in our inferences. The results remain qualitatively unchanged compared with those in the initial tables. Finally, we took into consideration the possible impact of the Salva Calcio decree which was adopted in Italy by the end of 2002 and instructed that Italian football clubs must treat football player contracts as intangible assets that should be amortized over the length of the contract. According to Morrow (2006), this decree allowed clubs to publish accounts that underestimate their true costs, hide real losses and present a misleading impression to users of financial statements. For this reason we performed again all tests excluding observations from Italian football clubs reducing the sample to 233 firm-year observations. The results remain qualitatively unchanged relative to our main empirical findings. Conclusion The scope of this study was to investigate the issue of corporate governance and its impact on the quality of accounting earnings published by European football clubs. Our sample includes governance and financial data from 67 football clubs over the period of 20062009. The evidence supports the argument that corporate governance quality mitigates aggressive earnings manipulation by football managers, as measured by income smoothing, accrual manipulation, and the tendency to report small positive income, dictating the necessity of sound corporate governance principles to protect the interests of shareholders and various stakeholders and to prevent the expropriation of wealth by managers (Rezende, Dalmacio, & Facure, 2010). Specifically, our findings suggest that clubs with more independent members on the board, smaller size and increased ownership by insiders (managers and officers) and institutions seem to achieve enhanced monitoring performance which leads to better alignment of interests among managers and various stakeholders. This effective monitoring is depicted by the improved quality of published accounting information by those clubs which are characterized by less discretionary manipulation of accounting numbers by the managers. Conversely, the separation of the CEO and board chairman roles does not seem to contribute significantly to the improvement of accounting quality since the specific variable was found insignificant in the majority of the empirical tests. Our findings could prove useful to football managers, regulators and potential investors since they have policy implications for all these related parties. Investors must take into consideration the efficiency of each club’s


518 Panagiotis Dimitropoulos corporate governance quality and demand supplementary information in order to reach a better investment decision when earnings are not highly informative. Also, managers must bear in mind that governance mechanisms could be a useful tool for improving the quality of financial reporting, a fact which may impact positively on the financial market (since most clubs are unlisted and the only source of financing is the banking sector, which will require transparent and reliable information). In addition, since regulators define the acceptable level of corporate governance standards, they must consider the aggregated effect on the actions of football managers of both ownership and board structure instead of considering the impact of each governance mechanism separately. Especially, the issue of board independence must be included in the official agenda of regulators on clubs’ governance reform and allow the participation of various stakeholders (fans, supporters, local representatives, etc.) in the decision and monitoring processes of corporate boards. Finally, the evidence of this study provides another impetus on UEFA and FIFA regulators in order to promote the issue of modern governance on professional football corporations. The UEFA financial fair play regulation moves in the proper direction yet UEFA must create the proper mechanisms for the enforcement of this regulation within the clubs’ daily operations. Without incorporating efficient monitoring and governance mechanisms in professional football clubs, UEFA’s restrictions will not be able to improve the current financial status of the European football industry. However, there are two limitations worth mentioning. First, the dataset is restricted to a specific region (EU) covering a single sport activity (football), and second, the data span a relatively short time period. Therefore, future research can extend the present findings by examining the relation between governance and earnings quality in other professional sport sectors (basketball) with increased interest from the public and within different world segments (US or Australia). Finally, another fruitful avenue for future research is to consider the impact of player contracts (and intangible assets in general) on the governance quality and the financial performance of the football clubs. Acknowledgements The author would like to thank the editor of ESMQ, Professor Taks and two anonymous reviewers for their useful comments and suggestions that resulted in a significant improvement of the paper. The author takes the sole responsibility for any errors and omissions.

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