The Role of Corporate Governance on the Relationship Between IFRS Adoption and Earnings Management: Evidence From Bangladesh

Purpose: This study investigates the relationship between IFRS adoption and earnings management (EM) i.e. discretionary accruals (DA) and real earnings management (REM) in developing economy like Bangladesh. Moreover, the study examine the relationship between corporate governance (CG) strength and EM as well as moderating role of CG strength on the relationship between IFRS adoption and EM. Design/methodology/approach: The study employs 94 firms listed in Dhaka Stock Exchange (DSE) for 6 years i.e. 564 firm years observation, over two time period as pre (2004-06) and post (2013/14-15/16) adoption of IFRS. Underpinning theory of the study is agency theory which explained the relationship among variables. Based on earlier literature a CG index is developed to measure the strength of CG. The study uses random effect GLS with robust regression in a balanced panel data. Findings: The results show that IFRS and CGI both have significant negative relationship with EM. Moreover, it is documented that the CG strength significantly moderates the relationship between IFRS and REM. It implies that the presence of good CG may help to attain the objectives of IFRS adoption Originality/value: To the best of the author’s knowledge, this is one of the first empirical attempts at providing evidence about the role of CG on the relationship between IFRS adoption and EM in Bangladesh. The findings of this study can be beneficial for the member of the regulatory bodies and researchers to formulate new policy and enhance corporate governance practices in Bangladeshi companies as well as develop a better framework for all stakeholders involved in financial reporting. Future studies may also investigate the interacting effect of corporate governance strength on other related variables which may influence the level of earnings management.


Introduction
It has long been the craving of most international equity markets to have a standardized or unique set of guidelines for preparation of financial statements. Over the decades, every country has had its own national standards but it does not ensure information uniformity because of different set of standards. Accounting theory argues that the purpose of financial reporting is essentially to reduce information asymmetry between corporate managers and parties contracting with their firm (Ball, 2001) and financial reporting reduces information asymmetry by disclosing relevant and timely information (Frankel & Li, 2004). IFRS is introduced as a single set of standard, to ensure the uniformity of accounting rules and regulation in practice. It may produce more reliable and simplified financial statements for the user. As a greater scope of comparability, managers are intended for less earnings management (Jeanjean & Stolowy, 2008). Earnings management is considered as an imperative determinant of the quality of financial reporting (Dechow, Ge, & Schrand, 2010;Key & Kim, 2020). Explicitly, a diverse evidence is documented in various studies related to the outcome of IFRS adoption on financial reporting quality (Brüggemann, Hitz, & Sellhorn, 2013;Kaaya, 2015). Several studies document that the quality of earnings is improved subsequent to the In recent times, Bangladesh has moved to the lower middle earner group in view of Gross National Income per capita (GNI) according to World Bank ("World Bank Press Release," July 01, 2015). Earlier, Bangladesh is recognized as a prime nation among the Least Developed Countries (LDC's) where Bangladesh represents as an example to other LDC's, for the development and implementation of the international policy. It requires an intensive study to identify the effect of IFRS adoption in the developing economy. In addition Bangladesh capital market has suffered a market scam in 2009-10 which wipe out the investment and trust of the small investors. It may be the outcome of ineffective regulation and weak financial reporting framework (Hasan, Hossain, & Rahman, 2014). Very few studies are conducted in respect of IFRS implementation procedures, its pros and cons as well as outcome of IFRS adoption in Bangladesh. Especially, the outcome of IFRS adoption on EM in Bangladeshi listed firms has not been studied so far. Thus, the study helps to comprehend the consequences of IFRS implementation on EM in developing economy like Bangladesh. The intent of the study can be identified in three parts: i) to examine the effect of IFRS adoption on EM in a developing economy, ii) to examine the affiliation between CG and EM, and iii) to explore the role of CG on the relationship between IFRS and EM.

Literature Review and Hypothesis Development
This study brings into light various issues related to International Financial Reporting Standard (IFRS), Earnings Management (EM) in terms of accruals management and real earnings management, Corporate Governance (CG), with the concentration on the effect of IFRS adoption on EM. Agency theory explain the theoretical background of the issue linked to the separation of ownership and management. Designing and implementation of accounting standard is an important aspect to improve decision making capacity of the investors and it also serves as an effective tool for managers performance evaluation (Scott, 2014). Financial reporting procedures provide information about management stewardship of resources which is required by the investors or other stakeholders for evaluation. Conflicting issue between management and users of financial reporting is explained through agency theory (Jensen & Meckling, 1976). This study is structured under the framework of agency theory which highlights the issue of agency conflict i.e. the relationship between management and owners as well as positive accounting theory (efficient contracting perspective and opportunistic perspective) where theory explains that managers are rational and choose accounting practices for their best interest (i.e. opportunistic), if possible (Scott, 2014). As it is not always possible for the firm to ensure efficient contracts over time. Moreover, managers judgment is often required for the preparation of the financial statement (Fama, 1980). In this aspect, accounting standards have been anticipated to reduce the opportunistic managerial behavior and reduce the of information asymmetry (Iatridis, 2010). The global movement for the adoption of IFRS as a single set of standard with its higher disclosure requirements to ensure transparency may tend to reduce managerial discretion and consequently EM (Byard, Li, & Yu, 2011;Wahyuni et al., 2020). ISSN 1923-4023 E-ISSN 1923

IFRS Adoption and Earnings Management
The implementation of IFRS may offer higher accounting quality by ensuring comparability and transparency of the financial statements which reduce the magnitude of earnings manipulation (Gordon, Jorgensen, & Linthicum, 2011;Hasan & Rahman, 2017;Kaaya, 2015;Nouri & Abaoub, 2014). Cai, Rahman, and Courtenay (2008) documented significant reduction of earnings management subsequent to the implementation of IFRS in different countries. The study of Chen et al. (2010) suggest that accounting information quality is enhanced by adopting IFRS where quality is measured in terms of management performance and the level of discretionary accruals. However, IFRS is principle based standards which evoke more discretion by managers, that may lead to higher manipulation income figure presented in the financial statement (Barth et al., 2008). Jeanjean and Stolowy (2008) suggest that the objective of IFRS implementation may not be accomplished by reducing the practice of EM. Similar results is documented by Callao and Jarne (2010). However, literature suggest that IFRS offer more strict accounting practice in comparison to local accounting standards due to higher level transparency and comparability of the financial statement. Thus, the study hypothesizes that, H 1 : The adoption of IFRS has significant negative relationship with earnings management

Corporate Governance and Earnings Management
Several studies conducted on the association between corporate governance and earnings management practices which is documented that the weak corporate governance induce earnings management practices within the firm (Abbadi, Hijazi, & Al-Rahahleh, 2016;Abdelkarim & Zuriqi, 2020;Habbash & Alghamdi, 2016). Earlier studies evidence that firm value is linked with both internal and external corporate governance (Cremers & Nair, 2005). Accordingly Brown and Caylor (2006) consider both internal and external issues of corporate governance and develop a firm specific corporate governance index based on Institutional Shareholder Services (ISS), which is considered for this study to develop CG index following previous studies (Moudud-Ul-Huq, 2015;Rahman, Al Bashir, Choudhury, & Rabby, 2014;Rouf, 2011). Recent study of Abbadi et al. (2016) suggest that earnings management is negatively associated with the strength of corporate governance mirror through CGI which includes the characteristics of company's board and audit committee, external audit quality, financial reporting. Accordingly, this study assumes that, H 2 : Corporate governance strength has significant negative relationship with earnings management

Moderating Effect Corporate Governance Strength on the Relationship Between IFRS and Earnings Management
There is a lot of study in perspective of IFRS adoption, corporate governance, and earnings management. However, the study linked with these three variables under the same framework is only a few. Prior studies highlighted that the better accounting standards (e.g IFRS) and strong corporate governance have positive effect on accounting information quality which lead to better financial reporting quality by reducing the extent of earnings management (Ajina, Bouchareb, & Souid, 2013;Al Matari, Al Swidi, & Fadzil, 2014;Bayk & Ramezanahmadi, 2016). According to Marra and Mazzola (2014) higher capacity of board during the adoption of IFRS restrain earnings management. In another study, Shawn, Jung, and Do (2015) identified that the IFRS adoption influence earnings management (i.e. reduce earnings manipulation), but only if the company has good governance. Recent study of Bonetti, Magnan, and Parbonetti (2016) documented that the firm with strong corporate governance measured by CG score, have experienced better accounting information quality in financial statements by reducing the extent of earnings management after the adoption of IFRS, even though the country have weak governance and low enforcement. Similarly, Liang and Shan (2013) documented that the earnings quality represent by accruals quality is improved following the implementation of IFRS only under the strong institutional settings which is measured by self constructed CG score. They also suggested for further study in relation to IFRS adoption and corporate governance. It is established by Baron and Kenny (1986) that the moderation is take place only when the following two conditions are satisfied: i) there is a strong relationship between moderating variables and dependent variables and ii) direct association between independent and dependent variables. A moderator is a qualitative or quantitative variable that affects the direction and/or strength of the relationship between independent variables and dependent variables. Moreover, in different study researchers use corporate governance as moderator to identify the outcome of corporate governance on financial reporting quality or earnings management (Al Matari et al., 2014;Bayk & Ramezanahmadi, 2016;Dakata & Hasn, 2016;Hui-Sung Kao & Wei, 2014;Kouki & Guizani, 2015;Nekhili, Amar, Chtioui, & Lakhal, 2016;Surifah, 2017). It is apparent from the literature that there is a close affiliation among IFRS adoption, corporate governance and earnings management. Based on that, this study hypothesizes that: ISSN 1923-4023 E-ISSN 1923 H 3 : Corporate Governance strength significantly moderate the relationship between IFRS and earnings management

Sample Selection
This study focus on the listed firms of Dhaka Stock Exchange (DSE) following IFRS adoption in Bangladesh which is covered 3 years each before and after the adoption of IFRS as BFRS by ICAB. The firms are selected based on the criteria that it must be listed in DSE and participate actively in the capital market for both tenure 2004-06 and 2013/14-15/16 of the study. The initial numbers of the listed firms and securities are 560 at the end of December, 2016(DSE, 2016. Out of those number, securities listing (266), financial firms (100) and government owned company (8) which are operated under close supervision of Bangladesh central bank and concern regulatory bodies, are excluded for the study as like previous studies (Hasan, Molla, & Khan, 2019;Ismail et al., 2013;Nouri & Abaoub, 2014). Subsequently, few companies (92) are not considered for the study as the firm were not listed in both time periods and/or published annual report. Based on above discussion, the study comprise 94 firms listed in Dhaka Stock Exchange (DSE) for 6 years i.e. (94*6)=564 firm years observation.

Research Model and Variable Definition
The study is carried out with an objective to investigate the effect of IFRS adoption on EM in a developing economy which helps us to understand the change in financial reporting quality after the conversion of local accounting standards to international standards. Figure 1 presents theoretical framework of the study which highlighted independent, dependent and moderating variables. To test the hypothesis, this study employs panel data in the course of multiple regression models which are related to IFRS adoption, CG and EM. The following variables are considered for those multiple regression to test the relationship among the variables: absolute value of discretionary accruals (│DA│) as dependent variable, IFRS adoption (IFRS) as independent variable and Corporate Governance Index (CGI) as moderating variable. The study also include a number of indicator and control variables in the study model by following previous research (Al-Rassas & Kamardin, 2015;Hasan et al., 2019;Ismail, Dunstan, & Van Zijl, 2010), namely audit quality (AQ) measured by the affiliation with big4 audit firms, company size in terms of assets (SIZE), structure of debt (LEV), yearly growth in terms of sales (GRT), return of assets (ROA). The specification of the study model is given below:

Earnings Management Model Specification
Earnings is considered as high quality when it provides precise information about the firm's performance which are relevant to the decision maker (Dechow et al., 2010). This study use discretionary accruals and real activities management as proxy of earnings management which are the mostly used and recognized proxy in literature by academicians (Ahmed, Neel, & Wang, 2013;Alhadab, Clacher, & Keasey, 2016;Ipino & Parbonetti, 2016). Discretionary accruals is the fraction of total accruals which is considered as dependent variable (AB_DA) of this study and measured by extended modified Jones model (Yoon, Miller, & Jiraporn, 2006) which is more appropriate compare to the modified Jones model due to better estimation and misspecification problems of the earlier models (Yoon, Kim, & Woodruff, 2012). Islam, Ali, and Ahmad (2011) and Islam (2014) identified that the extended modified Jones model is more fit than modified Jones model for Bangladesh in terms of R 2 value which is 83.8% for extended modified Jones model compare to 8.9% for modified Jones model. The proposed model for accruals estimation is presented in table 3 which explains that the total accruals mainly depends on three transforming factors: i) revenue from cash sales, ii) expenses in cash and iii) non-cash expenses including depreciation and retirement benefit expenses.
Here, represents the estimated coefficients of in equation (3.1). The discretionary accruals (DA) obtained from the equation (2) represent the differences between actual total accruals and the expected (non-discretionary) total accruals. Following Roychowdhury (2006) the study consider three approach for real activities manipulation: 1) Accelerated sales following by higher sales discount or convenient credit facility. 2) Lower cost of goods sold due to excessive production. 3) Insistently dropping aggregate discretionary expenses which includes advertising expenses, sales, general and administrative expenses, to improve net margin reported in the financial statements. Similar approach is applied by Zang (2011), Cohen and Zarowin (2010), Cohen, Mashruwala, and Zach (2010), Doukakis (2014) as well as Ipino and Parbonetti (2016) and provide evidence that those three metrics are useful to identify the real activities manipulation. Accordingly, this study consider accelerated sales, lower COGS and lower discretionary expenses to recognize real activities management which are decomposed in table 3. Table 3. Decomposition of CFO, production cost and discretionary expenses (9) CFOit = cash flows from operations taken from the statement of cash flows. Abnormal cash flow from operations is the actual CFO less the normal level of CFO calculated with the estimated coefficient from equation (9) (10) where PRODit = production costs, defined as the sum of cost of goods sold and the change in inventories from year t-1 to year t; (11) DISEXit = discretionary expenses defined as selling, general and administrative expenses for year t.

Corporate Governance Index (CGI)
Prior studies employ corporate governance index to evaluate the effectiveness of corporate governance practices or the compliance status of the company (Brown & Caylor, 2006;Ferdous, 2013;Mallin & Ow-Yong, 2013;Sathye, Islam, & Hu, 2014). This study measured corporate governance strength in terms of corporate governance index (CGI) which is developed by considering the framework (where applicable) given by Brown and Caylor (2006). Similar type of framework is also used by Salleh (2009) in Malaysian context, Moudud-Ul-Huq (2015) and Rahman et al. (2014) in Bangladesh context as well as other researcher in different perspectives (Bonetti et al., 2016;Cormier, 2014) to construct corporate governance index. Brown and Caylor (2006) employ Institutional Shareholder Service's (ISS) data to measure the firm specific corporate governance index and following that this study measured corporate governance index (CGI) based on the issue of compliance and non-compliance with particular corporate governance provision. The study use dichotomous approach for indexing, where '1' (one) is given for compliance and '0' (zero) for non-compliance. Corporate governance strength of each company is articulated by the index value which is derived from the equation 12.

Descriptive Analysis
The annual report of the firm is used to extract data required for the study. Following the data collection, the value of discretionary accruals and aggregate value of real earnings are estimated by applying extended modified Jones model (Yoon et al., 2006) and Roychowdhury model (Roychowdhury, 2006) respectively. Table 4 characterize mean of the absolute value of discretionary accruals (AB_DA) which is 0.0413 with standard deviation of 0.0963, similar to the study of Humayun Kabir, Sharma, Islam, and Salat (2011);Houqe, Van Zijl, Dunstan, and Karim (2010). At the same time, real earnings activities (i.e. aggregate value of abnormal cash flow from operations, abnormal discretionary expenses and abnormal production costs) represents the mean value of 3.37e-09 with the standard deviation of 0.5830; similar to the study of Bhuiyan (2015), where minimum value is -2.472 and maximum value is 2.702, which means that the company are engaged in real earnings management in both direction. CGI score represents the strength of corporate governance, which is range from minimum 0.24 to maximum 0.96. The mean value of the CGI score is 0.6256 with standard deviation of 0.2519, which is similar to the study Moudud-Ul-Huq (2015) and Bhuiyan, Ullah, and Biswas (2007).

Correlation Matrix and Multicollinearity
Correlation analysis is applied to get information about the strength of relationship and direction among the variables (Pallant, 2011). This study performed correlation analysis to reveal the relationship and direction among dependent, independent and control variables.  Table 5 shows correlation matrix which represent the relationship and direction among all study variables. The table shows that there is significant negative correlation between IFRS and AB_DA which means that IFRS adoption may reduce the extent of EM in view of discretionary accruals (Barth et al., 2008;Chen et al., 2010). Similar result is documented for the relationship between CGI and AB_DA which means that better corporate governance may guide to lower level of discretionary accruals (Abbadi et al., 2016;Bekiris & Doukakis, 2011). Except one, all variables have correlation below 0.90 which shows that there is no sign of multicollinearity. Only exception is the relationship between IFRS and CGI i.e. 0.927 which may be the cause of dummy variable (Allison, 2012) represent by IFRS. For further investigation of this issue, this study check the VIF and tolerance value. Literature suggest that, the VIF and tolerance value is more appropriate to identify the issue of multicollinearity (Hamilton, 2012). A range of acceptable VIF value is mentioned in the literature. The rule of thumb is that the VIF value should be below 10 which is mostly recommended in the literature (Allison, 2012;Hair, Black, Babin, Anderson, & Tatham, 2006). Table 6 represent the VIF and tolerance value of the different regression model and it shows that none of the VIF score cross the cut off level or more than 10. Accordingly, it can be mentioned that none of the model have issue of multicollinearity.

Test for Normality and Autocorrelation
Jarque-Bera normality test shows that the data is normal as p-value is insignificant which refers to null hypothesis is accepted. The study conduct Wooldridge test for autocorrelation to check the issue of serial autocorrelation, which indicates that there is no serial autocorrelation, as p-value is insignificant i.e. null hypothesis is accepted. In addition, Ramsey RESET test is done to identify the issue of endogeneity problems. Result shows that the model does not have any such issue, p-value insignificant (Prob > F = 0.6231), means accept the null hypothesis which refers to unlikely present of any misspecification problem in the model (Adib & Xianzhi, 2019;Ramsey, 1969).

Regression Results
Moreover, the moderating effect of corporate governance index (CGI) on the relationship between IFRS and earnings management is estimated in Eq.5 and Eq.6. The result shows that corporate governance index (CGI) negatively moderates the relationship between IFRS and RM. The direct positive relationship between IFRS and RM, changes to negative relationship (-1.66) at 5% level of significance. It means that the adoption of IFRS reduce the level of real earnings management in presence of good corporate governance. Similarly, Hastuti, Ghozali, and Yuyetta (2016) documented that internal control structure negatively moderate the relationship between IFRS and RM. However, CG does not have influence on the relationship between IFRS and discretionary accruals. Besides, audit quality and size of the company have significant influence on the practice of earnings management.

Conclusion
This study focused on the relationship between IFRS adoption and earnings management in Bangladesh. To the best of researcher knowledge, this study is one of very few which examine the effect of IFRS adoption on both proxy of EM, namely discretionary accruals and real activities management. Moreover, this study investigates the moderating role of corporate governance strength on the relationship between IFRS adoption and EM for the very first time. The results of the study shows that IFRS adoption has significant negative effect on both earnings management proxies, i.e. it helps to reduce the level of EM. Similar results are documented for the relationship between corporate governance strength and earnings management. Moreover, this study explore that corporate governance strength significantly moderates the relationship between IFRS adoption and real earnings management. The study has theoretical, practical and policy implication as well as methodical and academic contribution in the context of IFRS adoption in developing country like Bangladesh. Hence, the application of IFRS by Bangladesh can serve as an exemplary nation for other least developed countries. Accordingly, this study can be beneficial for the member of the regulatory bodies and researchers to formulate new policy and enhance corporate governance practices. Future studies may also investigate the interacting effect of corporate governance strength on other related variables which may influence the level of earnings management.