Does Corporate Governance Affect Earnings Management? Evidence from the US P&C Insurance Industry

Our study investigates whether corporate governance plays a role in mitigating earnings management in the US Property and Casualty insurance industry. Using a direct measure of managerial bias, our results show the following : first, stock-based components of CEO compensation are associated with reserving practices only when we control for the cross-effect between these components and the presence of a Big4 external auditor; second, independent directors, part of internal company monitoring mechanisms, and the main shareholder, among the external monitoring mechanisms, are effective in mitigating earnings manipulation; and third, the preliminary exercise on the effect of Sarbanes Oxley regulation coming into force reveals that the new regulation on governance has minimal or no impact on the relationship between corporate governance and earnings management in the insurance industry – it has long been heavily regulated for risk and governance.