Earnings Quality: A Missing Link between Corporate Governance and Firm Value

Abstract

The existing literature concerning governance-value relationship is inconclusive as it assumes that the association is direct. A theoretical argument suggests that the effective corporate governance reduces the information asymmetry through better financial reporting quality. This serves as a tool to reduce this information risk. Following the argument, our study is an attempt to investigate the mediating role of earnings quality, a measure of financial reporting quality, in governance-value association. For estimation, we used a panel data of 214 non-financial listed firms in Pakistan for the period 2003-2014 and employed one-way random effect estimator for the SUR system, as suggested by Biørn (2004). Our findings show that the corporate governance effectively improves the earnings quality and value of the firm, which approves the monitoring role. Moreover, earnings quality contributes positively in maximizing the value of the firm and the results demonstrate that better earnings quality partially mediates the governance-value association. It is concluded that corporate governance not only improves the value of the firm directly, but also indirectly through the channel of earnings quality.