Corporate Governance: The international journal of business in society

Corporate governance and investors' perceptions of earnings quality: Egyptian perspective

Ibrahim El‐Sayed Ebaid,
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Ibrahim El‐Sayed Ebaid, (2013) "Corporate governance and investors' perceptions of earnings quality: Egyptian perspective", Corporate
Governance: The international journal of business in society, Vol. 13 Issue: 3, pp.261-273, https://doi.org/10.1108/CG-02-2011-0011
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 Corporate governance and investors’
perceptions of earnings quality: Egyptian
perspective
Ibrahim El-Sayed Ebaid
Downloaded by ARAB ACADEMY FOR SCIENCE, TECHNOLOGY & MARITIME TRANSPORT At 01:46 24 February 2018 (PT)
Ibrahim El-Sayed Ebaid is
based at the Department of
Accounting, Faculty of
Commerce, Tanta
University, Tanta, Egypt.
Received February 2011
Accepted March 2011
DOI 10.1108/CG-02-2011-0011
Abstract
Purpose – The purpose of this paper is to test whether corporate governance mechanisms promoted
by the Egypt Code of Corporate Governance are effective in enhancing investors’ perceptions of
earnings quality.
Design/methodology/approach – The study uses a 2 £ 2 experimental design with a strong level of
corporate governance versus a weak level of corporate governance to explore the relation between
corporate governance practices and the perceived quality of reported earnings.
Findings – The findings of the study reveal that strong corporate governance is associated with higher
perceptions of earnings quality than weak corporate governance. These results suggest that the
voluntary adoption of the Egypt Code of Corporate Governance by Egyptian firms enhances the
investors’ perceptions of the quality of the financial reporting process.
Research limitations/implications – The results of the study should be considered by regulators in
Egypt with regard to the Egypt Code of Corporate Governance, which was issued in October 2005.
However, owing to the relatively small sample size, these findings should be interpreted with caution.
Originality/value – This study contributes to the limited body of research on the impact of corporate
governance on investors’ perceptions of earnings quality by examining this impact in Egypt, where
corporate governance is still not mandatory.
Keywords Corporate governance, Boards of directors, Audit committees, Earnings quality, Egypt,
Regulation
Paper type Research paper
Introduction
Earnings quality is a major dimension of the financial reporting quality, as earnings constitute
a premier source of firm-specific information (Francis et al., 2004). Empirical research
(e.g. Biddle et al., 1995; Liu et al., 2002; Francis et al., 2003) has documented that investors
refer to earnings more than any other summary measure of firm performance, such as
dividends and cash flows. Earnings are used as a primary input factor in asset valuation
models (e.g. Ohlson, 1995; Pope and Wang, 2005). Also, earnings play an important role in
contracting being used in both debt covenants and compensation agreements (e.g. Watts
and Zimmerman, 1986). Recent accounting failures in the USA (e.g. Enron, WorldCom), as
well as in Europe (e.g. Ahold, Parmalat) have deteriorated the confidence in the financial
reporting practices of public firms. Many reforms have been initiated to strengthen corporate
governance practices and, therefore, restore investors’ confidence in the integrity of the
financial reporting process not only at the country level (e.g. the Sarbanes-Oxley Act of 2002
in the USA), but also at an international level (e.g. Organisation for Economic Co-operation
and Development) and at the supranational level (e.g. European Commission, 2003).
Implicit in corporate governance reforms is the underlying belief that properly structured
corporate governance mechanisms are expected to enhance the quality of reported
earnings because they provide effective monitoring of management in the financial reporting
process (Cohen et al., 2004). Prior research has presented evidence that the mechanisms of
VOL. 13 NO. 3 2013, pp. 261-273, Q Emerald Group Publishing Limited, ISSN 1472-0701 j CORPORATE GOVERNANCE j PAGE 261
 corporate governance play an important monitoring role, and therefore have a positive
impact on the quality of reported earnings (e.g. Frankel et al., 2002; Balsam et al., 2003;
Carcello and Nagy, 2004; Lobo and Zhou, 2006; Shen and Chih, 2007; Jenkins and Velury,
2008; Dey, 2008; Cohen et al., 2008; Bowen et al., 2008; Gul et al., 2009; Jiang and
Anandarajan, 2009; Lin and Hwang, 2010; Dimitropoulos and Asteriou, 2010).
Although the association between corporate governance mechanisms and earnings quality
has examined extensively in the developed markets (USA and Europe), much less is known
about this association in emerging markets. For example, Liu and Lu (2007) demonstrate
empirically that Chinese listed firms with higher corporate governance levels have lower
levels of earnings management. Machuga and Teitel (2007) found that the quality of
earnings increased after the implementation of the corporate governance code in Mexico.
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Sarkar et al. (2008) indicate that boards that have directors with multiple appointments
exhibit higher earnings management in India. In contrast, Abdul Rahman and Ali (2006)
reveal that earnings management is positively related to the size of the board of directors in
Malaysia, while there is no significant relationship between other corporate governance
mechanisms (independence of board and audit committee) and earnings management. Ali
Shah et al. (2009) find a positive relationship between corporate governance and earnings
management for Pakistani listed firms. Al-Abbas (2009) finds no evidence that corporate
governance factors mitigate against earnings management in the Saudi environment. Also,
Chalevas and Tzovas (2010) find that mandatory corporate governance mechanisms had no
impact on earnings manipulation in Greece.
The purpose of this study is to provide insight into this ongoing debate by examining the
association between corporate governance mechanisms and the perceived quality of
reported earnings in Egypt as an example of a thin/emerging market. In fact, the Egyptian
environment is an interesting setting in which to assess the relation between corporate
governance mechanisms and investors’ perceptions of the quality of reported earnings for
three reasons. First, financial statements are the main source of information available to
investors in the Egyptian capital market. Thus, most transactions in the Egyptian capital
market are made based on accounting data, especially earnings. Second, Egypt has
pursued a policy of harmonization between the Egyptian Accounting Standards and the
International Accounting Standards since 1997. International accounting standards, as
principles-based standards, involve considerable judgment and provide managers with
substantial discretion. Egypt is a code-law country where accounting standards are
established and enforced by government. The financial system of Egypt remains
bank-oriented, and there is a weak level of investor protection and high conformity
between financial reporting and taxation. These attributes of code-law countries give the
preparers of reports incentives to issue low-quality financial reports despite the mandated
adoption of high-quality accounting standards (e.g. Ball et al., 2000; Leuz et al., 2003. Third,
Egypt responded to the growing attention to corporate governance in recent years by
reforming the Egypt Code of Corporate Governance: Guidelines and Standards in October
2005. However, the main difference between corporate governance environment in Egypt
and corporate governance in other developed markets is that the Egypt Code of Corporate
Governance was introduced neither on a mandatory basis (such as in the USA) nor on a
comply-or-explain basis (such as the UK). The Egypt Code of Corporate governance is
completely voluntary, and there is no obligation for Egyptian firms to follow it or to offer any
explanation about their failure to apply it.
This study examines two of the corporate governance mechanisms that are the focus of
recent regulations and prior studies:
1. the attributes related to the organization; and
2. the functioning of the board of directors in general and its audit committee in particular.
By using a 2 £ 2 experimental design with a strong board of directors versus a weak board of
directors and a strong audit committee versus a weak audit committee, the findings of the
study reveal that a stronger (weaker) board of directors or audit committee will result in a
higher (lower) level of investors’ perceptions of earnings quality. These results suggest that

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PAGE 262 CORPORATE GOVERNANCE VOL. 13 NO. 3 2013
 the voluntary adoption of corporate governance practices by Egyptian firms enhances
investors’ perceptions of the quality of financial reporting process.
The rest of the paper is organized as follows: the next section briefly describes the
institutional setting of the financial reporting process in Egypt. The third section deals with
the related literature and hypotheses development. The fourth section describes the
research method; the fifth section presents the analysis of research results. The final section
provides a summary conclusion.

Background and motivation for the study

In the 1990s the Egyptian government introduced economic liberalization to move towards a
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being free market economy. A privatization program was introduced and the Egyptian stock
exchange reopened in 1992. To enhance the reliability of the market, the Egyptian
Government issued Capital Market Law 95/1992 (L95-1992). This established the Capital
Market Authority (CMA), a controlling body resembling the Securities and Exchange
Commission in the USA. Under L95-1992, registrants are required to file their audited
financial statements with the CMA within three months from the end of the fiscal year and
publish a summary of them in two newspapers, with at least one of them being in Arabic. In
fact, financial statements are the main source of information available to investors in
Egyptian capital market. The financial analysis industry is only in an early stage of
development, and listed firms do not disclose earnings forecasts. Thus, most transactions in
the Egyptian capital market are made based on accounting data, especially earnings.
Therefore, the importance of earnings for market pricing is very high, and a functional
fixation on earnings is very common in stock pricing in Egypt.
The Egyptian government, as a part of the reform process, has pursued a policy of
harmonization between Egyptian Accounting Standards (EAS) and International Accounting
Standards (IAS). The implementation of IAS was conceived as a gradual process. In
October 1997, Decree No. 503 of the Minister of Economics was issued to establish 24 EAS,
based on IAS with some adaptation for local conditions. In late 2006, a new set of EAS was
issued pursuant to Decree No. 243 of the Minister of Investment, thus replacing the old set
issued under Decree No. 503/1997. This new set of EAS includes 35 EAS based on the
International Financial Reporting Standards (IFRS). Egypt is a code-law country, where:
B accounting standards are established and enforced by government;
B the financial system of Egypt remains bank-oriented, with a small number of banks
providing the majority of financing for firms;
B there is a weak level of investor protection; and
B there is high conformity between financial reporting and taxation.
Prior research (e.g. Ball et al., 2000; Leuz et al., 2003; Burgstahler et al., 2006; Bushman and
Piotroski, 2006) has documented that these attributes of code-law countries give the
preparers of reports incentive to issue low-quality financial reports, despite the mandatory
adoption of IFRS.
Egypt responded to the growing attention to corporate governance in recent years by
reforming the Egypt Code of Corporate Governance: Guidelines and Standards in October
2005. This code includes a number of rules that focus on various aspects of corporate
governance, especially the board of directors, the audit committee, external auditors, an
internal audit department, the disclosure of social policies and avoiding conflicts of interest.
With respect to the board of directors, the code states that firms should have a board of
directors that is responsible for closely monitoring the general status of the firm without
delegation of this task to others (Rule 3-7). The board is responsible for reviewing internal
controls and assessing their appropriateness and efficiency (Rule 3-19), and is responsible
for risk management in accordance with the nature of the firm’s activities, size, and the
market in which it operates. With regard to board composition and meetings, the code states
that the board should comprise a majority of non-executive directors with an appropriate mix

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VOL. 13 NO. 3 2013 CORPORATE GOVERNANCE PAGE 263
 of skills and technical and analytical experience. All of the non-executive directors should
dedicate the time and attention necessary to fulfill their responsibilities, and should not
accept assignments that could be seen to be a conflict of interest (Rule 3-4). The board of
directors should meet at least once every three months (Rule 3-17); non-executive directors
can meet at any time with management for consultation on any of its tasks, with or without the
attendance of the executive directors (Rule 3-18).
With respect to the audit committee, the code states that an audit committee should
comprise at least three non-executive board members, at least one of which should have
adequate financial and accounting expertise. If the number of non-executives on the board
of directors is fewer than three, one or more members may be appointed from outside the
firm (Rule 6-1). The audit committee is responsible for performing many functions, including:
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B evaluating the efficiency of the financial manager and other financial staff;
B examining the internal controls;
B reviewing the financial statements before submission to the board of directors;
B reviewing the firm’s accounting policies;
B reviewing the audit plan with the external auditor;
B assessing the qualifications, performance, and independence of the external auditor and
providing recommendations regarding external auditor appointments and remuneration;
and
B approving the external auditor’s engagement to provide non-audit services and
determining appropriate remuneration (Rule 6-2).
Finally, the code states that the audit committee should meet periodically at least once every
three months with a specified agenda (Rule 6-3).
However, the main difference between corporate governance environment in Egypt and
other developed markets is that corporate governance rules in Egypt are neither introduced
on a mandatory basis (such as in the USA) nor on a comply-or-explain basis (such as in the
UK). The Egypt Code of Corporate Governance is completely voluntary; there is no
obligation for Egyptian firms to follow it or to offer any explanation should they fail to apply it.
In its introduction, the code states that ‘‘These rules form guidelines for the correct and
proper conduct of corporate management, according to international practice and
standards that achieve an equitable arrangement of stakeholders’ interests. We hope the
directors of firms, financial institutions, professional committees and shareholders will
introduce and promote these rules, using them as a yardstick to measure their
achievement’’.
From the above analysis, the prevailing environment of the financial reporting process in
Egypt is characterized as a market where there are institutional structures that give the
preparers of reports the incentive to issue low-quality financial reports. Under such an
environment, it is interesting to examine the effectiveness of the introduction of the Egypt
Code of Corporate Governance in enhancing investors’ perception of earnings quality in
Egypt.

Literature review and hypotheses development

The effectiveness of corporate governance in overseeing the financial reporting process is
fundamental to preserving investors’ confidence in capital markets. Better corporate
governance mechanisms are expected to improve investors’ perceptions of the reliability of
firm performance as measured by earnings. Bauer et al. (2004) found that an investor
holding a long position in a good governance portfolio and a short position in a bad
governance portfolio earned an annual return of 2.1 percent for a European Monetary Union
portfolio and 7.1 percent for a UK portfolio. Gompers et al. (2003) found that well-governed
firms outperformed their poorly governed counterparts; well-governed firms had higher
equity returns and were valued more highly. Ashbaugh-Skaife et al. (2006) showed that the

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PAGE 264 CORPORATE GOVERNANCE VOL. 13 NO. 3 2013
 quality of corporate governance mechanisms is significantly and positively associated with a
firm’s credit rating. Chang et al. (2009) indicated that in the post-SOX period, the market’s
perception of earnings quality has improved, and therefore firms’ cost of equity capital has
decreased. Chang and Sun (2010) found that the market valuation of earnings surprises was
significantly higher for firms that disclose stronger corporate governance functions.
Holder-Webb and Sharma (2010) found that professional lenders’ perceptions of the
financial reporting reliability are a function of the strength of the board of directors.
The two corporate governance mechanisms considered in this study are the board of
directors and the audit committee.

The board of directors

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The board of directors assumes an important role in corporate governance. Due to the
separation of corporate management and ownership, boards exist to protect the interest of
shareholders (DeZoort and Salterio, 2001). The board of directors is charged with the
monitoring and disciplining of senior management, therefore assuring the quality of financial
reporting. Several studies (e.g. Beasley, 1996; Klein, 2002; Anderson et al., 2004) have
provided evidence regarding the importance of the role of the board of directors in
monitoring financial reporting, and therefore mitigating the manipulation of accounting
information.
Prior research reveals that the effectiveness of the board of directors’ oversight role could be
influenced by some attributes such as board size, board independence (percentage of
outside directors on the board), board members’ expertise, and meeting frequency. Larger
boards may be more effective in monitoring senior management due to the increased ability
to distribute the oversight load over a greater number of observers. Large numbers of board
members with varied expertise could increase the synergetic monitoring of the board in
reducing the incidence of earnings manipulation. A positive significant relationship has been
founed between board size and a firm’s financial performance. Xie et al. (2003) and Peasnell
et al. (2005) suggested that larger boards are related to a lower level of discretionary
accruals. Outside directors have an incentive to monitor management because the value of
their human capital is partially determined by the effectiveness of their monitoring
performance (Fama and Jensen, 1983). Therefore, independent (outside) directors are
preferable as they can increase the effectiveness of the board monitoring function and
ensure a high quality of reported earnings (Gupta and Fields, 2009). Dechow et al. (1996)
found that firms whose CEO also chaired the board of directors were more likely to be
subject to accounting enforcement actions by SEC for GAAP violation. Beasley (1996)
suggested that the proportion of independent directors on the board was negatively related
to the likelihood of financial reporting fraud. Klein (2002) found that board independence
and board size were negatively associated with abnormal accruals. Xie et al. (2003)
suggested that greater independent, outside representation on the board, a background in
corporations, finance, or law, and meetings frequency were related to a lower level of
discretionary accruals. Anderson et al. (2004) found that board independence and board
size were associated with increased accounting report integrity, and therefore a lower cost of
debt financing. It has been suggested that earnings management is negatively associated
with the independence of the board of directors and its audit committee. Ahmed and
Duellman (2007) documented that the percentage of outside directors is associated with
more conservative (less aggressive) accounting choices. Research has suggested that
staggered boards (a potent anti-takeover device) as a proxy of the quality of corporate
governance were associated with lower likelihoods of committing fraud and smaller
magnitudes of absolute unexpected accruals. Jaggi et al. (2009) concluded that the quality
of earnings was higher for firms with a higher proportion of independent directors on the
board.
Based on the above analysis, the first hypothesis of this study is that a large board of
directors, composed of a majority of independent (outside) directors who have adequate
financial literacy and expertise, and that meets more frequently, is more able to play a

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 stronger oversight role in the financial reporting process, and therefore will be positively
related to the quality of reported earnings. This leads to the first testable hypothesis:
H1. Investors’ perceptions of earnings quality will be higher in the presence of stronger
board of directors than when the board of directors is weaker.

Audit committee
Given its diverse responsibilities, the board of directors delegates some of its oversight to
the audit committee and other committees of the board. Since the beginning of the 1990s,
the effectiveness of audit committees in monitoring the financial reporting process has
become one of the most significant themes in corporate governance debates (Gendron and
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Bedard, 2006). The audit committee is responsible for recommending the selection of an
external auditor, ensuring the soundness and quality of internal accounting and control
practices, and monitoring the independence of the external auditor from senior
management (Anderson et al., 2004). McMullen (1996) suggests that the existence of an
audit committee is associated with a lower incidence of shareholder litigation alleging
management fraud, quarterly earnings restatements, SEC enforcement actions, illegal acts,
and auditor turnover due to accounting disagreements with management.

Prior research reveals that the effectiveness of the audit committee’ oversight role could be
influenced by some characteristics such as the independence of audit committee members,
financial literacy and expertise, and activity (number of committee meetings per year).
Menon and Williams (1994) found that those audit committees that did not meet or met less
frequently were less likely to perform their monitoring function properly. Abbott et al. (2004)
found that firms that have audit committees composed entirely of independent directors
meeting at least twice annually were less likely to be sanctioned by the SEC for fraudulent or
misleading financial reporting. DeZoort and Salterio (2001) argue that the audit committee’s
financial expertise increases the likelihood that detected material misstatements will be
communicated to the audit committee and corrected in a timely fashion. Klein (2002)
suggests a negative relationship between the independence of an audit committee and
abnormal accruals. Abbott et al. (2004) found that the independence of an audit committee,
the presence of at least one member with financial expertise, and meeting at least four times
per year, showed a significant and negative association with the occurrence of restatement.
Anderson et al. (2004) found that an independent audit committee was associated with
increased accounting report integrity and therefore a lower cost of debt financing. Yang and
Krishnan (2005) found that firms were more likely to have internal control weaknesses if their
audit committees were less independent and had less financial expertise or, more
specifically, had less accounting financial expertise and non-accounting financial expertise.
Persons (2005) found that the likelihood of fraud was reduced when audit committees are
completely independent. Yang and Krishnan (2005) find that audit committee size is
negatively associated with earnings management. Lin et al. (2006) found evidence
suggesting a negative association between the size of audit committees and the occurrence
of earnings restatement. Dhaliwal et al. (2006) found that accruals quality was positively
associated with audit committee accounting expertise, but not with financial or supervisory
expertise.
Based on the above analysis, the second hypothesis of the study is that an audit committee
composed entirely of independent (outside) directors who have adequate financial literacy
and expertise and meet more frequently is more able to play a stronger oversight role in the
financial reporting process, and will therefore be positively related to the quality of reported
earnings. This leads to the second testable hypothesis:
H2. Investors’ perceptions of earnings quality will be higher in the presence of a
stronger audit committee than when the audit committee is weaker.

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Table I Manipulation of the board of directors and audit committee effectiveness
Board of directors
Weak
The firm has a small board of
directors
The firm has a board of directors The firm has a board of directors The audit committee does not
with a majority of executive
(CEO) members
The board does not contain an
adequate number of directors
who have financial literacy,
especially expertise in
accounting
The board of directors has no
regular meeting agenda
Research method
Design
The study uses a 2 £ 2 experimental design with a strong board of directors versus a weak
board of directors and a strong audit committee versus a weak audit committee, yielding
four case versions. Participants were randomly assigned to one of these four case versions.
Each case includes a cover sheet, case material, and additional questions. The cover sheet
requested participation and provided general instructions including a guarantee of
anonymity. The case material began with background information about a hypothetical listed
firm, including firm size (sales volume), industry information (intensity of competition and
firm’s market share), information about listing status, ownership structure, and financial
statements containing five years of data. The case material revolved around a realistic case
involving a listed firm belonging to the chemical industry. Subsequently, the case material
included information about the firm’s corporate governance structure (the board of directors
and audit committee). The manipulation of the board of directors and audit committee is
shown in Table I; these manipulations are based on the significant attributes noted in the
literature (e.g. Dechow et al., 1996; Beasley, 1996; Abbott et al., 2004; Klein, 2002; Xie et al.,
2003; Abbott et al., 2004. Given the lack of empirical evidence as to which specific attributes
of the board of directors and audit committee are of greatest importance, these attributes
were co-varied to reflect either a strong or a weak board of directors and/or audit committee.
Since the purpose of the study is to examine the impact of corporate governance practices
on investors’ perceptions of earnings quality, the background information was held constant
for all four case versions. The participants were required to use this information to perform a
judgment related to the quality of reported earnings. The case also included a demographic
question to explore the profile of respondents. In order to ensure that the case material was
intelligible, a pilot test was conducted. The draft case material was sent to ten persons with
expert knowledge (four academics and six investors); this pilot test resulted in some minor
revisions that improved the intelligibility of the case material.
Participants
The participants were 141 postgraduate students of accounting and finance from three
Egyptian universities. Experimental cases were mailed to 326 students in May 2010 with a
random assignment to the four case scenarios. From the 326 cases mailed out, 141
responses (43.2 percent) were usable. Each participant was asked to review the
Audit committee
Strong Weak Strong
The firm has a large board of The firm has an audit committee The firm has an audit committee
directors consisting of three executive consisting of three
(CEO) directors non-executive (outside)
directors
The audit committee includes at
with a majority of non-executive include any member that has least one member who has
(outside) members financial literacy, especially financial literacy, especially
expertise in accounting expertise in accounting
The board contains an adequate The audit committee has no The audit committee meets
number of directors who have regular meeting agenda regularly at least twice per year
financial literacy, especially
expertise in accounting
The board of directors meets
regularly, at least four times per
year
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VOL. 13 NO. 3 2013 CORPORATE GOVERNANCE PAGE 267
 experimental case provided, and to provide answers to questions relating to his/her
perception of earnings quality. The capital market of Egypt, as a thin/emerging market,
suffers from a lack of institutional investors. The majority of investors in the capital market in
Egypt are individual (less mature or non-professional) investors. Non-professional investors
are a widely dispersed, heterogeneous group of individuals, which makes them difficult to
recruit as participants in accounting experiments. Therefore, experimental accounting
researchers who are interested in the behavior of non-professional investors typically use
graduate business students as a proxy for these individuals. Previous research has
suggested that experiments that focus on the judgments of non-professional investors only
require participants who possess basic accounting and investing knowledge. The
participants in this study have adequate accounting and investing knowledge, and
therefore could fit these criteria. Accordingly, the perceptions of the participants in the study
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are expected to proxy for the perceptions of investors in the capital market in Egypt.

Dependent variable
Based on the information provided in the case material, participants were asked to indicate
their judgment regarding the quality of reported earnings on a seven-point Likert-type scale.
The low endpoint of the scale was labeled ‘‘very low quality’’, while the corresponding label
for the high end of the scale was ‘‘very high quality’’.

Independent variables
The experimental treatment in the study is the board of directors and audit committee
manipulated as either weak or strong. As stated previously, the attributes that affect the
effectiveness of the board of directors and audit committee mentioned in Table I are the
attributes noted in the previous literature.

Results
Profile of participants
Table II shows the demographic profile of the responding participants. As shown in Table II,
the majority of participants (65 percent) were male, the participants’ mean age was about
31.8 years, their mean accounting and finance work experience was about 9.3 years, and
the mean number of involvements in making investment decisions (i.e. investment on the
capital market) was about 5.2. Statistical tests revealed that there was no significant
difference in dependent variable due to the differences in these demographic variables
(p ¼ 0:503). The absence of significant differences in the dependent variable due to
differences in the demographic variables suggests that random assignment to experimental
cases was successful.

Table II Profile of participants

Gender
Male
n 92
Percent 65
Female
n 49
Percent 35
Total
n 141
Percent 100
Age
Mean 9.3
Standard deviation 1.98
Number of involvements in investment decisions
Mean 5.2
Standard deviation 2.11

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 Manipulation check. In order to ensure that the board of directors and audit committee
effectiveness conditions were perceived by the participants as intended in the research
design, a manipulation check was conducted to check the manipulation of experimental
treatments. For the board of directors manipulation the participants were asked to indicate, on
a seven-point Likert-type scale (ranging from 1 ¼ very low to 7 ¼ very high), their judgment on
the ability of the board of directors to oversee management effectively. Similarly, for audit
committee manipulations the participants were asked to indicate, on a seven-point Likert-type
scale (ranging from 1 ¼ very low to 7 ¼ very high), their judgment on the ability of the audit
committee to oversee management effectively. The participants who received the stronger
board of directors version of the case indicated a mean (standard deviation) of the board
effectiveness in monitoring management of 6.41 (0.51), compared to 1.82 (1.01) for the
participants who received the weaker board of directors version of the case. The difference in
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means is statistically significant at p ¼ 0:000 (t ¼ 16:87). Similarly, the participants who

received the stronger audit committee version of the case indicated a mean (standard
deviation) of audit committee effectiveness in monitoring management of 5.88 (0.99),
compared to 1.59 (1.06) for those participants who received the weaker audit committee
version of the case. The difference in means is also statistically significant at p ¼ 0:000
(t ¼ 11:88). In general, the results cited above reveal that the participants perceived the
manipulations as intended for both the board of directors and audit committee.

Earnings quality judgment. H1 and H2 examine the impact of the effectiveness of the board
of directors and audit committee on investors’ perceptions of earnings quality. Tables III and
IV present the means and standard deviations for the effect of the board of directors and
audit committee on investors’ perceptions for the main effects (Table III) and for each
experimental condition (Table IV). As shown in Tables III and IV, the results suggest that a
stronger board of directors and a stronger audit committee will result in more favorable
judgments on earnings quality than a weaker board of directors and a weaker audit
committee. Table V presents the ANOVA results for the impact of the board of directors and

Table III Means (standard deviations) of earnings quality judgment: categorized by main
effect
Sample size Earnings quality Standard deviation

Board
Stronger 73 5.958 0.806
Weaker 68 3.720 2.131
Committee
Stronger 67 6.000 0.866
Weaker 74 3.541 2.043

Note: aParticipants assessed the quality of reported earnings on a seven-point scale ranging from
1=very low quality to 7= very high quality

Table IV Means (standard deviations) of earnings quality judgment: categorized by

treatment group
Strong board Weak board Overall

Strong committee 6.500 5.428 5.923

(0.674) (0.851) (0.935)
Weak committee 5.416 1.545 3.562
(0.515) (0.820) (2.085)
Overall 5.958 3.720 4.816
(0.806) (2.131) (1.965)

Note: aParticipants assessed the quality of reported earnings on a seven-point scale ranging from
1=very low quality to 7= very high quality

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 Table V Analysis of variance (ANOVA) of earnings quality judgment
df Mean square f-value p-value

1 1,084.661 2,027.614 0.000

1 74.253 138.806 0.000
1 74.971 140.146 0.000
1 23.826 44.539 0.000
137 0.535

Notes: n ¼ 141, R 2 ¼ 81 per cent

audit committee on earnings quality judgment. The results mentioned in Table V reveal that
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the board of directors has a significant impact on the investors’ perceptions of earnings
quality (p ¼ 0:000), as does audit committee (p ¼ 0:000). Also, there is a significant
interaction between the two (p ¼ 0:000). Accordingly, the ANOVA results presented in
Table V and the cell means presented in Tables III and IV support the hypotheses that a
stronger (weaker) board of directors or audit committee will result in more (less) favorable
judgments on earnings quality. These results suggest that the voluntary adoption of
corporate governance practices by Egyptian firms enhances investors’ perceptions of the
quality of the financial reporting process, and therefore influences their investment
decisions.

Conclusion
This study aimed to examine the impact of corporate governance practices on investors’
perceptions of earnings quality in Egypt as an emerging market where corporate
governance is still voluntary. These particular conditions increase the importance of
exploring the impact of the voluntary adoption of the Egypt Code of Corporate Governance
by Egyptian firms on investors’ judgments (decisions). The two main features of corporate
governance examined in this study are the board of directors and the audit committee. By
using a 2 £ 2 between-subjects experimental design with a strong level of effectiveness of
the board of directors versus weak level of effectiveness of the board of directors and a
strong level of effectiveness of the audit committee versus a weak level of effectiveness of
the audit committee, the findings of the study reveal that investors significantly assessed
higher (lower) earnings quality judgments when the board of directors was stronger
(weaker) and/or when the audit committee was stronger (weaker). These results suggest
that the voluntary adoption of the Egypt Code of Corporate Governance by Egyptian firms
enhances the quality of the financial reporting process, and therefore influences investors’
decisions.
The results of the study have significant implications for regulators and researchers in Egypt.
First, the results mentioned above show the importance of corporate governance
mechanisms in enhancing the quality of the financial reporting process. Thus, these
results should be considered by regulators in Egypt in order to begin the necessary actions
for making Egypt Code of Corporate Governance – issued on October 2005 by the Ministry
of Investment and still voluntary – legally binding. Second, the study provides evidence of
how investors respond to the strength of a firm’s corporate governance when making
investment decisions. Further research is needed to examine how other stakeholders
respond to the strength of a firm’s corporate governance when making their decisions. A
number of individual attributes could affect the strength of the board of directors and audit
committee; this study did not conclude which of those attributes had a greater or lesser
impact on investors’ judgments. Thus, future research is needed to examine the impact of
those attributes individually.

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About the author

Dr Ibrahim El-Sayed Ebaid is Assistant Professor of Accounting at the Faculty of Commerce,
Tanta University, Egypt. He obtained his PhD in Accounting from Tanta University, Egypt. His
research interests lie in financial reporting, auditing, and corporate governance. He has
published several papers in international refereed journals, as well as in numerous
conference proceedings, and has written several chapters in books. Dr Ibrahim El-Sayed
Ebaid can be contacted at: ebaid2010@yahoo.com

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