The Sheep Watching the Shepherd: The Monitoring Performance of Boards with Employee Representatives

The board of directors is key to monitoring management, but the asymmetric information between the board and management is an obstacle to effective monitoring. Using a sample of firms listed on the Stockholm Stock Exchange, this study investigates to what degree employee representatives contribute to the board’s monitoring of financial reporting. Controlling for alternative model specifications and potential sample selection bias, we find evidence for lower abnormal accruals in firms with employee representation. This suggests that firms with employee representation are less engaged in earnings management. Additional tests show that both income-increasing and income-decreasing earnings management occur less frequently in firms with employee representation.