Board external connectedness and earnings management

In this study we explore how board external connectedness is related to firm's earnings management. Board external connectedness is gauged by the percentage of board members with at least one external board membership, and earnings management is gauged by the level of discretionary accruals from the modified Jones model. We postulate that externally connected directors could learn something from their connected firms, and this experience could be translated into monitoring effectiveness which in turn reduces a firm's level of earnings management. We use the sample consisting of 5940 firm-year observations from the listed firms in Taiwan in 2007–2011 sampling period to test the learning-effect hypothesis. The empirical finding supports this hypothesis by showing that board external connectedness is negatively correlated with the level of earnings management and that the negative relation is more conspicuous for the same-industry connectedness. However, the negative relation between board external connectedness and earnings management becomes insignificant when the firm has an external financing plan. Finally, independent directors' same-industry connectedness does reduce the level of earnings management when the firm has an external financial plan.