CORRELATION ANALYSIS RESULTS 1 DESCRPTIVE STATISTICS

401 to correlation among variables, the correlation matrix confirms that no multicollinearity exists between the variables since none of the variables correlates above 0.80 or 0.90. All variables have a correlation of less than 0.40. TABLE 2 CORRELATIONS AMONG VARIABLES EQ B IN D B D FINE X P B D C R O S S B D TE N U R E B D S IZE LN S A LE S LE V R O A B IG 4 EQ 1 BIND - .103 1 BDFINEXP -.019 .104 1 BDCROSS .130 .134 .167 1 BDTENURE .180 .023 - .166 .139 1 BDSIZE .067 - .267 - .141 .081 .061 1 LNSALES .159 -.020 .069 .321 .241 .288 1 LEV -.023 -.041 .035 .051 -.030 .022 .134 1 ROA -.004 .040 .051 .022 .097 .086 .169 - .133 1 BIG4 .013 .011 .065 .167 .081 .045 .130 .011 .033 1 Significant at the 0.01 level; Significant at the 0.05 level 4.3 MULTIVARIATE ANALYSES Table 3 presents the results from the multiple regression analyses. All the models tested in this study are highly significant at 0.01 percent level. TABLE 3 REGRESSION RESULTS Panel A Panel B Panel C t-Statistic t-Statistic t-Statistic Constant -4.699 -4.768 -4.629 BIND -2.299 2.665 -2.309 BIND 2 -2.852 BDFINEXP -0.054 0.020 402 BDFINEXP_DUM 0.048 BDCROSS 2.540 2.416 2.502 BDTENURE 4.602 4.543 4.568 BDSIZE -0.189 0.030 -0.187 LNSALES 2.515 2.517 2.501 LEV -1.277 -1.090 -1.280 ROA -0.617 -0.803 -0.621 BIG4 -0.781 -0.831 -0.789 DUM_YR04 -0.021 -0.083 -0.022 DUM_YR05 -0.769 -0.921 -0.768871 Adjusted R 2 0.056 0.083 0.058 F-Value 5.605 7.259 5.605 N 831 831 831 Significant at 0.01; Significant at 0.05 From the analysis conducted, it was found that three out of the four characteristics of board of directors tested in the basic model of this study are significantly associated with earnings quality Panel A – Table 3. The results presented show significant association between board independence BIND, board governance expertise BDCROSS and board firm-specific expertise BDTENURE and earnings quality. No association was found between board financial expertise BDFINEXP and earnings quality. Contradictory to the prediction of agency theory, this study finds a significant negative association between board independence BIND and earnings quality at 0.05 percent level. It suggests that firms with lower board independence have higher earnings quality. The finding is, however, similar to the earlier paper by Norman et al. 2005 and Hashim and Susela 2008b, which report a significant but contrary sign of a relationship between board independence and earnings management for Malaysian companies. Klein et al. 2005 raise the issue of the applicability of the agency theory assumptions on the monitoring role by outside directors in countries with a concentrated ownership structure, especially in the hands of family members. As the ownership and control is tighter in family firms, they argue that the demand for outside directors becomes less. Furthermore, Bhagat and Black 2002, p.239 argue that ‗if the shift in board composition responds to external pressure, then it may be neither efficient nor an endogenous response to firm characteristics‘. Siregar and Utama 403 2008 find that the existence of independent boards do not significantly associated with efficient earnings management in Indonesia as the establishment of the committee is only to comply with the regulations and not for monitoring purposes. As found in this study, most firms in the sample surpassed one-third threshold as also noted by Abdullah, 2004. Hence, this leads to speculation as to whether the one-third requirement actually works and suggested by Abdullah 2004 although they appear independent they may not be truly independent. It is found that board governance expertise BDCROSS proxy by proportion of directors on the board with directorships in other companies and board firm-specific expertise BDTENURE proxy by average number of years of board service of independent non-executive directors are highly significant at 0.05 and 0.01 percent, respectively. Both results show a positive and highly significant relationship between governance expertise and firm-specific expertise with earnings quality. The greater the number of board committee holding additional directorships in other firms enhances the quality of financial reporting of the firm as they gain governance expertise through knowledge they acquire in other firms Bedard et al., 2004. Additionally, the results provide strong support of the relationship between firm-specific expertise BDTENURE and financial reporting quality, as can be seen in Table 3, which reveals a highly significant relationship between board tenure and earnings quality. Experience as a board member in the same company for a longer period of time helps independent directors gain firm- specific expertise of the company‘s operation and its other executive directors Bedard et al., 2004. The increase in the number of years independent directors serve in the firm gives them the ability to effectively monitor the management, which results in a higher quality of financial reporting. Although governance expertise and firm-specific expertise of boards is found to be highly significant, this study does not find any association between board financial expertise BDFINEXP and earnings quality. The finding is, however, consistent with Abdul Rahman and Mohamed Ali 2006 for Malaysian cases. They argue that the establishment of audit committees has yet to achieve its intended goal in Malaysia. 404

4.4 ADDITIONAL ANALYSES

To ascertain the credibility of initial analysis, two additional tests were carried out; 1 allowing for a possible non-linear relationship between board independence and earnings quality; and 2 using a different proxy to measure board financial expertise.

4.4.1 Alternative Measurement for Board Independence

Thus far, the variable BIND is treated as a linear variable. The result, as shown in Panel A, suggests that board independence is significantly associated with earnings quality but in the opposite direction as predicted by the agency theory. It is possible that the relationship between board independence and earnings quality is non-linear. Studies by Bhagat and Black 2002 and Garg 2007 suggest that different proportions of independent directors may differently impact firm performance. For example, Bhagat and Black 2002 suggest that firms may achieve the benefit of firm-specific knowledge when they have a significant number of inside directors – for example 30 percent – but the benefits may be detrimental when there are too many. Klein 2002 reports that firms with a majority-independent board i.e. 51 percent or more produce the highest relationship with abnormal accruals. Although it may be valuable to have a majority of independent directors, Garg 2007 documents that the impact of board independence on firm performance is less when the proportion of board independence is greater than 60 percent. To further investigate this issue, the study adds a squared term for board independence BIND 2 to the basic model in Panel A to test whether the relation between board independence and earnings quality is non-linear. Results reported in Panel B indicate that both the estimated coefficient of board independence BIND and the square of board independence BIND 2 are statistically significant at the 5 percent level. Other individual results are not significantly different from the earlier model and all the variables that are significant in Panel A remain significant. Given the estimated values for the BIND and BIND 2 coefficients, the turning point of the relation between board independence and earnings quality is: Maximisation point = -b 2 2b 3 = -5.283 2-6.137 = 43.04  43 405 The results suggest that as board independence increases the sample firms report higher earnings quality, consistent with the agency theory prediction. However, when board independence reaches beyond 43 percent, a negative association between board independence and earnings quality emerges. In other words, the results suggest that firms with board independence greater than 43 percent will begin to report lower earnings quality.

4.4.2 Alternative Measurement for Board Financial Expertise

The Bursa Malaysia listing requirements require that at least one member of the audit committee is a member of the Malaysian Institute of Accountants. Additionally, the listing requirements stipulate that if they are not a member of the Malaysian Institute of Accountants, they must have at least three years working experience and must have passed the examinations specified in Part 1 of the 1 st Schedule of the Accountants Act 1967 or must be a member of one of the associations of accountants as specified in Part 11 of the 1 st Schedule of the Accountants Act 1967. To carry out additional analysis, this study uses a dummy variable to represent firms with a qualified accountant. Consistent with the prior study by Abdul Rahman and Mohamed Ali 2006, the variable board financial expertise is measured using an indicator variable with the value of one if at least one member is a qualified accountant and 0 otherwise. As for the results regarding the board financial expertise as shown in Panel C, treating the board financial expertise variable as a dummy variable does not influence earnings quality significantly. Specifically, the results show no significant coefficient with regards to the association between board financial expertise BDFINEXP_DUM and earnings quality. This suggests that at least one member of the board being a member of an accounting association or body is not an effective measure to achieve board financial expertise.

5. CONCLUSION, LIMITATIONS AND SUGGESTIONS FOR FUTURE RESEARCH

This paper examines the effect of board independence and board expertise on the financial reporting quality in Malaysia. Using an accrual quality as a measure of earnings quality, this study finds that board expertise is one of the most important determinants of financial reporting quality. Specifically, this study finds a positive significant relationship between additional board directorship and average tenure of