This article was downloaded by: [Carlos Alves]

On: 12 October 2013, At: 01:47

Publisher: Routledge
Informa Ltd Registered in England and Wales Registered Number: 1072954 Registered office: Mortimer House,
37-41 Mortimer Street, London W1T 3JH, UK

Applied Financial Economics

Publication details, including instructions for authors and subscription information:
http://www.tandfonline.com/loi/rafe20

Does the Latin model of corporate governance perform

worse than other models in preventing earnings
management?
a b
Carlos F. Alves & Ernesto Fernando R. Vicente
a
Faculty of Economics, CEF.UP, University of Porto, Porto, Portugal
b
Universidade Federal de Santa Catarina, NPGO, FEPESE and PPGC do Centro Sócio-
Econômico, Florianópolis, Santa Catarina, Brasil

To cite this article: Carlos F. Alves & Ernesto Fernando R. Vicente (2013) Does the Latin model of corporate governance
perform worse than other models in preventing earnings management?, Applied Financial Economics, 23:21, 1663-1673

To link to this article: http://dx.doi.org/10.1080/09603107.2013.844322

PLEASE SCROLL DOWN FOR ARTICLE

Taylor & Francis makes every effort to ensure the accuracy of all the information (the “Content”) contained
in the publications on our platform. However, Taylor & Francis, our agents, and our licensors make no
representations or warranties whatsoever as to the accuracy, completeness, or suitability for any purpose of the
Content. Any opinions and views expressed in this publication are the opinions and views of the authors, and
are not the views of or endorsed by Taylor & Francis. The accuracy of the Content should not be relied upon and
should be independently verified with primary sources of information. Taylor and Francis shall not be liable for
any losses, actions, claims, proceedings, demands, costs, expenses, damages, and other liabilities whatsoever
or howsoever caused arising directly or indirectly in connection with, in relation to or arising out of the use of
the Content.

This article may be used for research, teaching, and private study purposes. Any substantial or systematic
reproduction, redistribution, reselling, loan, sub-licensing, systematic supply, or distribution in any
form to anyone is expressly forbidden. Terms & Conditions of access and use can be found at http://
www.tandfonline.com/page/terms-and-conditions
 Applied Financial Economics, 2013
Vol. 23, No. 21, 1663–1673, http://dx.doi.org/10.1080/09603107.2013.844322

Does the Latin model of corporate

governance perform worse than
other models in preventing earnings
management?
Carlos F. Alvesa,* and Ernesto Fernando R. Vicenteb
a
Faculty of Economics, CEF.UP, University of Porto, Porto, Portugal
b
Universidade Federal de Santa Catarina, NPGO, FEPESE and PPGC do
Centro Sócio-Econômico, Florianópolis, Santa Catarina, Brasil
Downloaded by [Carlos Alves] at 01:47 12 October 2013

Traditionally, the Latin model of corporate governance had been a predominant

model in some countries; however, this model is increasingly becoming out of
fashion. Using a database of Portuguese and Brazilian firms, we investigated
whether the Latin model performs worse than other models (i.e. variants of the
Continental and Anglo-Saxon models) in terms of preventing earnings manage-
ment. We conclude that, in general, companies that adopt the Latin model have
lower levels of earnings management than other companies and that switching
from the Latin model to another model does not cause a generalized decrease in
the level of discretionary accruals. Additionally, firms that move away from the
Latin model are not predominantly those with extremely high levels of discre-
tionary accruals.

Keywords: corporate governance; government policy and regulation; earnings

management; accounting disclosure
JEL Classification: G30; G38; M40

I. Introduction 2003. The European Union issued a directive (2006/43/

Corporate governance mechanisms for the supervision
and control of financial disclosure are not entirely effi-
cient, as revealed by several accounting scandals in
Europe and the United States early in this century. In
response to these scandals, authorities have established
rules to improve corporate governance and ensure the
quality of financial reporting. In this context, the
Sarbanes Oxley Act (SOX) was approved in the United
States in July 2002, and the Securities and Exchange
Commission (SEC) approved additional rules in March
CE) aimed to improve the efficiency of the quality control
of audits. Several other countries have introduced changes
to their laws to improve corporate governance and safe-
guard the quality of disclosed financial information.
The issue of earnings management is related to the topic
of corporate governance and, in particular, to the organi-
zation of mechanisms for auditing and controlling the
financial reporting process. Several studies have sought
to associate earnings management with certain features of
corporate governance. Piot and Janin (2007) found that the
presence of an audit committee curbs upward earnings

*Corresponding author. E-mail: calves@fep.up.pt

NPGO is a Corporate Governance Research Center. FEPESE is the Foundation for Socio Economic Studies and Research of the Federal
University of Santa Catarina (UFSC). PPGC is the Accounting Graduate Program at UFSC.

© 2013 Taylor & Francis 1663

 1664
management, whereas Peasnell et al. (2005) found no
evidence that the audit committee can influence the level
of earnings management. Nevertheless, Klein (2002) con-
cluded that the more independent the audit committee is,
the lower the levels of earnings management will be. Xie
et al. (2003) and Beasley (1996) reached similar conclu-
sions about the effect associated with the independence of
the audit committee. Finally, Osma and Noguer (2007)
found no correlation between the existence of an indepen-
dent audit committee and the level of earnings
management.
The existing literature is predominantly composed of
data from companies whose governance model corre-
sponds to one of the two internationally dominant para-
digms: (i) the Anglo-Saxon or ‘one-tier’ model or the (ii)
Continental, Germanic, or ‘two-tier’ model. In the first
model, a single board of directors maintains the com-
pany’s management/supervision and governance/control.
This board integrates an audit committee filled exclusively
Downloaded by [Carlos Alves] at 01:47 12 October 2013
by nonexecutive directors. In the second model, two sepa-
rate boards exist, which maintain the company’s govern-
ance (supervisory board) and management (management
board), respectively. In this model, the audit committee is
framed within the supervisory board.
Some countries, including Italy, Portugal, Brazil and
other Latin and Latin American countries, have long
used governance models that differ from both the Anglo-
Saxon and Continental models. In these countries, the so-
called ‘Latin model’ has historically prevailed. In this
model, the audit committee is an autonomous board
(‘audit board’) that is independent of the supervisory
board and the board of directors. The aim of the audit
board is to supervise the board of directors, check account-
ing records and review the management reports, accounts
for the financial year and the statutory audit.
In principle, the specificity and autonomy of the audit
board would favour higher effective control over the audit
process, thus decreasing the level of earnings manage-
ment. Members of the audit board in the Latin model do
not participate in any decision-making process, their sal-
aries do not depend on company performance and they are
entirely free to decide how the firm’s operations and
financial situation are reported. However, there is a large
information asymmetry between executive directors and
audit board members in the Latin model. Members of the
audit board do not belong to the highest governing board
of the company and do not usually keep track of the
company’s daily business, which places them at an infor-
mative disadvantage.1 Moreover, audit board members
usually devote less time to monitoring the company’s
activities than members of the audit committees of the
Continental and Anglo-Saxon models. In 2009 in
1
Madhogarhia et al. (2009) has indicated that the primary reason some companies manage their earnings more than others is that their
information asymmetries are more severe.
C. F. Alves and E. F. R. Vicente
Portugal, the audit boards of companies adopting the
Latin model met 6.5 times on average (one company
reported only one meeting during the whole year). In
contrast, the audit committees of companies adopting the
Anglo-Saxon and Continental models met an average of
10.7 and 16.5 times, respectively, over the year (CMVM,
2010). These findings led the Corporate Governance
White Book, prepared under the aegis of the Portuguese
Corporate Governance Institute (Silva et al., 2006), to
recommend extinction of the Latin model.
Conflicting arguments have suggested that a company’s
use of the Latin model can result in lower or higher levels
of earnings management. However, there is no empirical
evidence showing which effect is likely to have greater
impact. To fill this gap in the literature, in this article, we
focused on a sample of companies from Portugal and
Brazil. In these countries, firms can choose from among
several models of corporate governance, including the
Latin model and models based on the internationally
dominant paradigms (i.e. the one-tier and two-tier mod-
els). Under this circumstance, it is possible to determine
whether the levels of earnings management of companies
adopting the Latin model differ from those of companies
adopting models considered to be more robust. It is also
possible to check whether switching from the Latin model
to another model is more frequent among companies with
high levels of discretionary accruals and whether such a
switch can reduce earnings management practices.
In particular, we sought to answer the following three
research questions: (1) Do companies using the Latin
model of corporate governance perform worse in terms
of preventing earnings management compared to compa-
nies using other models?, (2) Is the Latin model more
likely to be abandoned by companies with higher or
lower levels of discretionary accruals? and (3) Does a
company’s discretionary accrual level decrease after it
switches from the Latin model to another model? Our
main goal is not to prove that adoption of the Latin
model necessarily causes lower discretionary accruals,
but to provide evidence that the Latin model does not
necessarily imply a higher level of discretionary accruals
than other, more robust models.
In this article, we used the Jones modified model to
calculate discretionary accruals (Jones, 1991; Dechow
et al., 1995), and we applied univariate and panel data
regression analyses to answer the research questions.
Given that we sought to compare the earnings management
practices of different groups of companies, we used the
absolute values of discretionary accruals in our analyses
(similar to others, e.g. Warfield et al., 1999; Bartov et al.,
2000). In total, we analysed 482 observations related to 56
nonfinancial companies that were part of the stock market
 Does the Latin model of corporate governance perform worse?
indices PSI20 and IBrX50 (16 companies from Portugal
and 40 from Brazil) between 1997 and 2009.
This article contributes to the literature by increasing
the knowledge of governance models that are not the
international standards and by adding information related
to the issues of earnings management and corporate
governance. Although there are several studies on the
subject of earnings management, none has been based on
Portuguese and Brazilian companies. Therefore, our arti-
cle is also novel in this area.
Our findings show that the theoretically ‘more robust’
models cannot be associated with lower levels of earn-
ings management and that switching from the Latin
model to another model does not inevitably reduce the
level of earnings management. Companies using the
Latin model usually showed earnings management levels
that were below those of other companies, and replacing
the Latin model by another model did not necessarily
decrease the level of discretionary accruals. A reduction
Downloaded by [Carlos Alves] at 01:47 12 October 2013
of discretionary accruals was only witnessed for firms
that already had lower levels of earnings management
before the switch. Companies that abandoned the Latin
model typically had above-average, but not extraordin-
ary, levels of discretionary accruals. Finally, companies
with dual listings (via ADR – American Depositary
Receipts) had lower levels of earnings management com-
pared to other companies, but the presence of the State
among the shareholders had no significant impact on the
earnings management level. These findings have regula-
tory implications because they show that more robust
models may possibly not have the performance expected
by regulators.
Our article is organized as follows: Section II describes
the governance models, particularly the Latin model,
which can be adopted by companies in Portugal and
Brazil. Section III describes the sample. Section IV
shows our findings regarding the research questions and
Section V summarizes the conclusions.
II. Portuguese and Brazilian Corporate
Governance Models
Portuguese corporate governance models
Portuguese law allows companies to choose one of the
three models: (i) the Latin model, comprising a board of
directors, audit board and statutory auditor; (ii) the Anglo-
Saxon model, comprising a board of directors (including
an audit committee and statutory auditor); or (iii) the
Continental model, comprising an executive board of
directors, general and supervisory board and statutory
2
See, indeed, CMVM (2010). Also, see Alves and Mendes (2004) for information on compliance with CMVM recommendations.
1665
auditor. Companies must choose one of these models.
Cherry-picking practices are not allowed.
In the Latin and Anglo-Saxon models, the board of
directors is responsible for managing the company. In
the Continental model, the executive management board
is in charge of management, but must obtain prior consent
from the general and supervisory board to perform certain
types of decisions. In the Latin and Anglo-Saxon models,
the board of directors may delegate powers to an executive
committee. Supervisory activities are the responsibility of
the statutory auditor in all models, together with the audit
board (Latin model), audit committee (Anglo-Saxon
model) and general and supervisory board (Continental
model). The general and supervisory board in the
Continental model must have an audit committee specifi-
cally devoted to perform a set of supervisory activities
identified by law. The powers of this committee are essen-
tially identical to those of the audit committee in the
Anglo-Saxon model. In all models, the main function of
the statutory auditor is to examine the financial reporting.
In 2006, the Portuguese Corporate Governance
Institute, through a white book, identified the underper-
formance of the audit boards in the Latin model as an area
of great concern (Silva et al., 2006; Alves and Mendes,
2009). They recommended the extinction of the audit
boards of the Latin model (in other words, the extinction
of the Latin model). Companies that have adopted the
Latin model are less compliant with the code of corporate
governance issued by the Portuguese securities regulator
(CMVM).2 5 years after the white book, the Latin model
continued to be prominent in Portugal (CMVM, 2010). At
the end of 2010, 72.7% of the 44 companies listed on the
major stock market adopted the Latin model, but these
companies represented only 43.0% of the market capitali-
zation. The Anglo-Saxon model was preferred by 22.7%
of companies (38.7% of market capitalization). Only 4.6%
opted for the two-tier model, although these companies
accounted for 18.3% of market capitalization. Therefore,
although more companies in Portugal use the Latin model,
they are generally smaller than other companies. The
reduced size of these companies and their consequently
smaller management and supervisory bodies are the most
commonly argued reasons for why they retain the Latin
model of corporate governance.
Brazilian corporate governance models
Although Brazil traditionally adopts the Latin model,
since 2000, other forms of governance have been avail-
able. In particular, there are three available models that
differ substantially from the Latin model and are closer to
Anglo-Saxon standards: the ‘New Market’ model, ‘Level
2’ model and ‘Level 1’ model. The New Market model has
 1666
higher requirements than the others in terms of transpar-
ency and good governance rules, while the Level 2 model
has an intermediate level of requirements. The Level 1
model has lower standards than the Level 2 and New
Market models; however, compared to the traditional
Latin model, the Level 1 model is still thought to ensure
demanding practices that are more aligned with interna-
tionally recognized standards.
Brazilian companies must comply with the corporate
governance guidelines of the Brazilian Securities
Commission (CVM). Regulated issues include the trans-
parency, structure and operations of general meetings;
structure and responsibility of the board of directors and
audit and financial statements. Companies with shares
traded in the American market (ADRs) (which, in Brazil,
adopt the rules of the New Market) must adopt some of the
practices of the Anglo-Saxon model, namely, structuring
the board of directors into executive and nonexecutive
members and organizing an audit committee within the
Downloaded by [Carlos Alves] at 01:47 12 October 2013
board.
One very important aspect that distinguishes traditional
companies from those adopting reputedly more robust
corporate models is the fact that the latter companies
establish audit committees, instead of relying on the
work of audit boards. Audit committees monitor the
actions of the executive directors with regard to the pre-
paration of financial statements, accounting choices and
the quality of internal control systems; monitor the activ-
ities of the internal auditor; hire an external auditor; dis-
cuss the external auditor’s duties; discuss relevant risks
and discuss the financial reports with the external auditor.
As in Portugal, the Latin model remains the most fre-
quently used model of corporate governance in Brazil. Of
the 321 companies listed on BM&FBovespa Stock
Exchange, 127 companies are still effectively adopting
the Latin model. The traditional market, where such com-
panies are listed, represents 49% of the market value, a
total of USD 3 trillion.
III. Data Set
The sample for this study included nonfinancial compa-
nies that are members of the major indices of Brazil
(IBrX50) and Portugal (PSI20). The sample period cov-
ered years from 1997 to 2009. Some companies were
listed at a date later than the beginning of the sample;
therefore, it was an unbalanced panel. Information needed
for the research was obtained from the CMVM website,
the CVM database, Economática, Sabi database,
Datastream and financial statements published on the
respective websites of the companies.
While selecting the sample, we excluded financial sec-
tor companies, as is usual in earnings management studies
C. F. Alves and E. F. R. Vicente
(among others, Sloan, 1996; Chan et al., 2006). We also
excluded companies with insufficient data from the beha-
viour analysis of financial results, particularly because
they had not been listed throughout the sample period.
The final sample consisted of 46 Brazilian and 16
Portuguese companies, with a total of 482 firm-year obser-
vations (333 observations on companies in Brazil, 149
observations on companies in Portugal). The level of dis-
cretionary accruals ranged from 0.0001 to 0.8076, with an
average of 0.0926 and a SD of 0.1017. The average and
SD were 0.09125 and 0.0917, respectively, for Portuguese
companies and were 0.0932 and 0.1060, respectively, for
Brazilian companies.
IV. Empirical Evidence
Univariate analysis
Question 1: Do companies using the Latin model of
corporate governance perform worse in terms of prevent-
ing earnings management compared to companies using
other models?
We compared the discretionary accrual levels of com-
panies employing the Latin model (‘Latin model’ subsam-
ple), including Portuguese and Brazilian companies, to
those employing other models (‘Other models’ subsam-
ple). Results of this comparison are shown in Panel A.I of
Table 1. The Latin model subsample had a lower average
level of discretionary accruals compared to the Other
models subsample (0.086 versus 0.103). The average
interquartile means of the two upper quartiles (Q1 and
Q2) were substantially lower in the Latin model compared
to those in the Other models. For the lower quartiles (Q3
and Q4), the averages of the two subsamples were not
statistically different. Therefore, the high average
observed for the Other models was due to companies
included in Q1 and Q2 and not those in Q3 and Q4; this
effect cannot be attributed to outliers.
The above findings are corroborated by the results
shown in Panel A.II. The level of discretionary accruals
of the Other models subsample exceeded the level
observed for the Latin model subsample for the maximum
(0.808 versus 0.562), 75th percentile (0.138 versus 0.106)
and median (0.066 versus 0.059), but not for the 25th
percentile (0.029 versus 0.031) or the minimum (0.000
in both cases).
Next, we combined the two subsamples into one, dis-
tributed the observations into four quartiles and calculated
the percentage of elements of each subsample that fell into
each quartile of the full sample (Table 1, Panel A.III).
Whereas only 21.7% of the observations of the Latin
model fell in the top quartile (Q1), the percentage of
observations of the Other models was 30.6%, with a
 Downloaded by [Carlos Alves] at 01:47 12 October 2013

Table 1. Discretionary accruals of the Latin model versus Other models

Latin model Other models Difference Latin model Other models Difference Latin model Other models Difference

Panel A – all sample Panel B – Portuguese sample Panel C – Brazilian sample

Panel A.I – discretionary accruals Panel B.I – discretionary accruals Panel C.I – discretionary accruals
averages averages averages

Sample average 0.086 0.103 –0.017 * 0.089 0.104 –0.014 0.084 0.103 –0.019 *
z-Stat –1.64 –0.71 –1.64
SD 0.086 0.122 0.093 0.085 0.082 0.126
N 299 183 128 21 171 162
Q1 [top] Average 0.199 0.257 –0.058 ** 0.210 0.210 0.000 0.190 0.260 –0.070 ***
z-Stat –2.25 0.00 –2.37
Q2 Average 0.083 0.094 –0.010 *** 0.086 0.120 –0.034 *** 0.081 0.090 –0.009 ***
z-Stat –3.04 –4.32 –2.39
Q3 Average 0.047 0.045 0.002 0.048 0.046 0.002 0.047 0.045 0.002
z-Stat 1.19 0.24 1.00
Q4 [bottom] 0.015 0.016 –0.001 0.013 0.019 –0.006 * 0.016 0.016 0.001
Average
z-Stat –0.62 –1.52 0.34
Panel A. II – discretionary accruals Panel B. II – discretionary accruals Panel C. II – discretionary accruals
percentiles percentiles percentiles

Maximum 0.562 0.808 –0.245 0.562 0.317 0.245 0.439 0.808 –0.368
75th Percentile 0.106 0.138 –0.032 0.106 0.150 –0.044 0.106 0.127 –0.021
Median 0.059 0.066 –0.006 0.063 0.101 –0.038 0.058 0.065 –0.006
Mann–Whitney 0.95 1.30 * 0.56
–Wilcoxon Stat
Does the Latin model of corporate governance perform worse?

25th Percentile 0.031 0.029 0.002 0.028 0.027 0.001 0.033 0.030 0.003
Minimum 0.000 0.000 0.000 0.001 0.002 –0.001 0.000 0.000 0.000
Panel A.III – percentage of observations Panel B.III – percentage of observations Panel C.III – percentage of observations
in sample quartiles in sample quartiles in sample quartiles

Q1 [top] Sample 21.7% *** 30.6% *** –8.9% *** 23.4% *** 38.1% *** –14.7% * 21.1% *** 29.6% *** –8.6% ***
t-Stat –130.22 223.67 –2.56 –40.82 342.15 –1.37 –119.2 139.8 –2.33
Q2 Sample 27.1% *** 21.3% *** 5.8% ** 25.8% *** 19.0% *** 6.7% 26.3% *** 23.5% *** 2.9%
t-Stat 83.47 –147.29 1.87 20.41 –155.52 0.77 39.7 –46.6 0.83
Q3 Sample 26.4% *** 22.4% *** 4.0% * 26.6% *** 14.3% *** 12.3% * 28.7% *** 21.0% *** 7.7% **
t-Stat 56.76 –103.65 1.28 40.82 –279.94 1.58 110.4 –121.2 2.31
Q4 [bottom] 24.7% *** 25.7% *** –0.9% 24.2% *** 28.6% *** –4.4% 24.0% *** 25.9% *** –1.9%
Sample
t-Stat –10.02 27.28 –0.28 –20.41 93.31 –0.44 –30.9 28.0 –0.55

Notes: (i) Panels A, B and C refer to complete sample, Portuguese subsample and Brazilian subsample, respectively; (ii) Panel I (I.A, I.B and I.C) reports the discretionary accrual averages
and z-stat for the test of equal averages between the Latin model and Other models subsamples; (iii) Panel II (II.A, II.B and II.C) reports, for the discretionary accruals, percentiles and
Mann–Whitney–Wilcoxon stat results for the test of equal median between the Latin model and Other models subsamples; (iv) Panel III (III.A, III.B. and III.C), in the two first columns,
reports the percentage of observations of the Latin model and Other models subsamples, respectively, in the complete sample (i.e. formed by the Latin model firms and Other models
1667

firms). The third column reports the difference between these percentages. In the first two columns, t-stat refers to Student’s t-test for binomial proportions (=25% under the null
hypothesis). In the third column, the null hypothesis is that proportions in each subsample (Latin model and Other models firms) are equal; (v). ***, ** and * denote statistical significance
at the 1%, 5% and 10% levels, respectively. Statistical tests are one-sided.
 1668
significant difference between these proportions (–8.9%).
Therefore, companies with higher levels of discretionary
accruals were usually those that adopted a non-Latin gov-
ernance model.
Panels (B) and (C) report findings for the Portuguese and
Brazilian companies, respectively. In both countries, the
average of the discretionary accruals was lower for the
Latin model than for the Other models, but this difference
was not statistically significant in the Portuguese case. In
contrast, the null hypothesis that the medians are equal (see
Panel B.II) was rejected for Portugal. In both cases, compa-
nies with the top levels of discretionary accruals were more
frequently those that adopted non-Latin models (see the
percentage of observations in Q1 in Panels B.III and C.III,
23.4% versus 38.1% and 21.1% versus 29.6%, respectively).
In short, we can conclude that companies employing the
‘more robust’ non-Latin models did not exhibit lower
management levels compared to those using the Latin
model. On the contrary, we may infer that companies
Downloaded by [Carlos Alves] at 01:47 12 October 2013
adopting the Latin model had, on average, lower levels
of earnings management compared to companies using
other models, mainly due to the companies with the high-
est levels of discretionary accruals.
Questions 2 and 3: Is the Latin model more likely to be
abandoned by companies with higher or lower levels of
discretionary accruals? Does a company’s discretionary
accrual level decrease after it switches from the Latin
model to another model?
Companies that have always adopted the Latin model
(‘All Time Latin’) had lower average discretionary
accruals than companies that switched from the Latin
model to another model. This finding was true when we
considered observations before the switch (‘Initial Latin’)
and after the switch (‘Former Latin’) (Table 2, Panel I).
Similarly, the medians of the Initial Latin and Former
Latin subsamples were significantly higher than the med-
ian of the All Time Latin subsample (Table 2, Panel II). In
terms of the quartile averages (Table 2, Panel I), except for
Q1 (where the null hypothesis of equality was not
rejected), the quartile averages for the Initial Latin sub-
sample were higher than those for the All Time Latin
subsample. The same finding was true for Q2 and Q3 for
the comparison between Former Latin and All Time Latin.
From these results, it cannot be concluded that the
companies that switched models had lower discretionary
accruals before or after switching than companies that
always had adopted the Latin model. On the contrary,
the switching companies generally had higher discretion-
ary accruals, both before and after switching, than com-
panies that did not switch models. This result was also true
for some interquartile averages, but not for the top (Q1)
quartile averages.
3
We thank an anonymous referee for this suggestion. The following values are not included in Table 2.
C. F. Alves and E. F. R. Vicente
Focusing on the comparison between the Initial Latin
and Former Latin subsamples, the level of discretionary
accruals generally did not decrease after the switch. The
difference in the average level of discretionary accruals
before and after switching was not significantly different
from zero (0.004). Regarding the interquartile averages,
the Initial Latin subsample had higher averages in Q3 and
Q4, but not in Q1 and Q2 (when the differences were not
significant). The null hypothesis (that their medians are
identical) was not rejected (Table 2, Panel II). Hence, the
results shown in Panels I and II of Table 2 allow us to
conclude that switching models does not result in a gen-
eralized reduction of earnings management practices. A
reduction was only perceptible for companies that already
had very low levels of discretionary accruals.
Panel III of Table 2 was created by merging all obser-
vations (All Time Latin, Initial Latin and Former Latin)
into a single pool and, subsequently, calculating and dis-
tributing the observations into quartiles. As shown in the
first three columns, the All Time Latin and Initial Latin
companies had proportions lower than 25% in Q1,
whereas the Former Latin companies had a proportion
higher than 25%. In Q2, the Initial Latin and Former
Latin companies changed roles. The last three columns
show the difference in proportions in each quartile and the
test to see if the difference is zero (i.e. if the proportions are
equal). In Q1, the proportions of the All Time Latin and
Initial Latin companies did not differ significantly from
each other, and both were smaller than the proportion of
the Former Latin companies. Therefore, we can conclude
that companies with extremely high earnings management
levels were not likely to leave the Latin model and that the
act of switching models did not prevent companies from
achieving high levels of discretionary accruals.
To investigate the effect of switching models by using
the firm approach,3 we computed the percentage of firms
that increased (or decreased) accruals in the year immedi-
ately after the switch. Accruals increased for 23 firms
(74.2%) and decreased for 8 firms (25.8%). The average
of accruals for the year immediately before switching was
0.06278, compared to 0.08406 for the first year after the
switch. When we compared the average of accruals for
each firm, considering all years before the switch with all
years after the switch, we found that the averages
increased for 52.3% of the firms. Moreover, the maximum
of the annual accruals for switching firms occurred after or
before the switch in 61.9% or 38.1% of cases, respectively.
The discretionary accruals of the firms that switched mod-
els exceeded the all-sample median (75th percentile) of the
corresponding year in 61.4% (27.5%) of cases before the
switch, compared to 50.5% (30.4%) of cases after the
switch, respectively. This finding provides evidence that
it was not predominantly those firms with extremely high
 Does the Latin model of corporate governance perform worse? 1669
Table 2. Analysis of impact of moving from Latin model to Other models

All Time Initial Latin Former Latin Average

Latin model model model differences

[A] [B] [C] [B]-[A] [C]-[A] [B]-[C]

Panel I – discretionary accruals averages

All sample average 0.079 0.096 0.093 0.018 ** 0.014* 0.004

SD/z-Stat 0.081 0.093 0.088 1.74 1.33 0.32
N 172 127 105
Q1 [top] Average 0.191 0.209 0.215 0.018 0.024 −0.006
z-Stat 0.72 1.18 −0.21
Q2 Average 0.074 0.092 0.094 0.018 *** 0.020 *** −0.002
z-Stat 6.38 4.26 −0.45
Q3 Average 0.039 0.060 0.044 0.022 *** 0.006 ** 0.016 ***
z-Stat 10.79 2.14 5.49
Q4 [bottom] Average 0.011 0.024 0.013 0.013 *** 0.002 0.010 ***
z-Stat 4.52 1.14 3.56
Panel II – discretionary accruals percentiles

Maximum 0.439 0.562 0.448

Downloaded by [Carlos Alves] at 01:47 12 October 2013

75th Percentile 0.101 0.111 0.136

Median 0.053 0.078 0.065 0.025 0.012 0.013
Mann–Whitney–Wilcoxon Stat 2.81 *** 1.36 * 0.73
25th Percentile 0.026 0.048 0.024
Minimum 0.000 0.002 0.000
Panel III – percentage of observations in all three subsamples quartiles

Q1 [top] All sample 20.9% *** 23.6% *** 33.3% *** 2.7% 12.4% *** −9.7% **
t-Stat −123.26 −35.86 197.20 0.57 2.64 2.05
Q2 All sample 20.9% *** 35.4% *** 19.0% *** 14.5% *** −1.9% 16.4% ***
t-Stat −123.26 271.53 −140.86 3.69 −0.48 −4.08
Q3 All sample 27.9% *** 26.0% *** 19.0% *** −1.9% −8.9% ** 6.9% **
t-Stat 88.05 25.62 −140.86 −0.49 −2.24 −1.74
Q4 [bottom] All sample 30.2% *** 15.0% *** 28.6% *** −15.3% *** −1.7% −13.6% ***
t-Stat 158.48 −261.28 84.52 −3.37 −0.37 3.02

Notes: (i) All Time Latin Model (A) refers to firms that adopt the Latin model during the entire sample period. Initial Latin Model (B)
refers to firms that change from the Latin model to Other model during the period that they adopted the Latin model. Former Latin Model
(C) refers to firms that change from the Latin model to Other model during the period that they adopted the Other model; (ii) Panel I
reports the discretionary accrual averages, for all samples and for each quartile. z-Stat reports to the null hypothesis test that the difference
between averages is null; (iii) Panel II reports the discretionary accrual percentiles and Mann–Whitney–Wilcoxon Stat for the test of
equal median between different subsamples; (iv) Panel III, in the first three columns, reports the percentage of the All Time Latin Model,
Initial Latin Model and Former Latin Model observations in the complete sample, respectively (i.e. in the sample formed by the three
subsamples). Last three columns report the difference between these percentages. In the three first columns, t-stat refers to Student’s t-test
for binomial proportions (=25% under the null hypothesis). In the last three columns, the null hypothesis is that proportions in each
subsample are equal; (v). ***, ** and * denote statistical significance at the 1%, 5% and 10% levels, respectively. Statistical tests are one-
sided.

levels of discretionary accruals that switched; however,
after switching, the firms more frequently recorded
extreme levels of discretionary accruals.
In short, we cannot conclude that the companies that
switched models had lower discretionary accruals;
instead, they generally had higher discretionary accruals
than companies that did not switch models. Companies
that left the Latin model typically had higher levels of
discretionary accruals than the companies that used the
Latin model all the time, but this finding was not
predominantly due to companies with the highest levels
of discretionary accruals. Companies that left the Latin
model were those with above-average, but not extremely
high, levels of discretionary accruals. Moreover, switch-
ing did not generally reduce the earnings management
practices. Reduction of discretionary accruals was only
perceived for firms that already had lower levels of earn-
ings management before switching. Considering all firms
that switched models, or considering firms with higher
levels of discretionary accruals, we can say that the levels
 1670
of discretionary accruals did not decrease after switching
away from the Latin model.
Other questions: Do companies with ADR or with State
ownership perform better or worse than others in prevent-
ing earnings management?
Of the selected companies, 21 companies (1 Portuguese
and 20 Brazilian) are listed on the NYSE through a dual-
listing system. ADR companies must meet conditions that,
in principle, can reduce the scope for earnings manage-
ment: they must meet new regulatory standards and must
submit their financial reports to two standards (local and
American). Thus, one would expect that ADR companies
could have different levels of earnings management com-
pared to non-ADR companies.
As shown in Table 3 (Panel A), the maximum, 75th
percentile, and median results were all lower for ADR
Downloaded by [Carlos Alves] at 01:47 12 October 2013
C. F. Alves and E. F. R. Vicente
compared to non-ADR companies. Although the average
level of discretionary accruals was also lower, this result
was not statistically significant. The proportion of obser-
vations of ADR companies in Q1 and Q2 of Panel A.III
was less than 25% and was less than the proportion of non-
ADR companies in Q2 (there was no significant difference
between the subsamples in Q1). Therefore, companies
under the dual-listing system appeared to have lower
levels of earnings management.
Because government interference could have an impact
on the earnings management, we investigated the relation-
ship between the participation of the State (Portugal or
Brazil) in the capital of the companies and its level of
earnings management. The State had direct or indirect
qualifying holdings (i.e. ≥2% of voting rights) in 7
Portuguese and 4 Brazilian companies in our sample.
When the averages of discretionary accruals were

Table 3. Discretionary accruals in firms with ADR and State ownership

Firms with State

ADR firms Other firms Difference shareholdership Other firms Difference

Panel A.I – discretionary accruals averages Panel B.I – discretionary accruals averages

Sample average 0.087 0.098 −0.011 0.092 0.093 −0.001

z-Stat −1.16 −0.07
SD 0.094 0.108 0.087 0.105
N 225 257 98 384
Q1 [top] Average 0.211 0.229 −0.018 0.193 0.229 −0.036*
z-Stat −0.81 −1.35
Q2 Average 0.078 0.093 −0.015*** 0.094 0.084 0.010***
z-Stat −5.93 4.25
Q3 Average 0.042 0.051 −0.009*** 0.060 0.044 0.015***
z-Stat −5.48 5.65
Q4 [bottom] Average 0.015 0.015 −0.000 0.020 0.014 0.006***
z-Stat −0.19 2.52
Panel A. II – discretionary accruals percentiles Panel B. II – discretionary accruals percentiles

Maximum 0.562 0.808 −0.245 0.562 0.808 −0.245

75th Percentile 0.110 0.116 −0.006 0.108 0.116 −0.008
Median 0.058 0.069 −0.011 0.082 0.059 0.024
Mann−Whitney− −6.60*** −54.63***
Wilcoxon Stat
25th Percentile 0.030 0.033 −0.003 0.039 0.029 0.010
Minimum 0.000 0.000 0.000 0.002 0.000 0.002
Panel A.III – percentage of observations in Panel B.III – percentage of observations in sample
sample quartiles quartiles

Q1 [top] Sample 24.0%*** 26.1%*** −2.1% 21.4%*** 26.0%*** −4.6%**

t-Stat −34.64 37.07 −0.73 −81.65 23.81 −1.91
Q2 Sample 21.8%*** 27.6%*** −5.8%** 39.8%*** 21.1%*** 18.7%***
t-Stat −111.62 90.98 −2.04 338.26 −89.30 8.04
Q3 Sample 27.6%*** 22.6%*** 5.0%** 19.4%*** 26.3%*** −6.9%***
t-Stat 88.53 −84.24 1.85 −128.31 29.77 −2.87
Q4 [bottom] Sample 26.7%*** 23.7%*** 2.9% 19.4%*** 26.6%*** −7.2%***
t-Stat 57.74 −43.81 1.07 −128.31 35.72 −2.97

Notes: (i) Panel A compares discretionary accruals of firms with listed ADR relative to all other firms. Panel B compares discretionary
accruals of firms in which the State (Portugual or Brazil) is a qualified shareholder (i.e has stock ≥2% of voting capital) relative to all other
firms; (ii) In other aspects, this table is similar to Table 1.
 Does the Latin model of corporate governance perform worse? 1671
Table 4. Regression analysis

Panel I – Latin versus Other models Panel II – moving from Latin to Other models

Equation 1 Equation 2 Equation 3 Equation 4 Equation 5

C 0.108 *** 0.108 *** 0.067 *** C 0.077 *** 0.092 ***
47.06 49.73 9.25 12.79 16.03
Country 0.005 –0.000 0.015 * Country 0.005 –0.012 **
0.75 –0.04 1.63 0.68 –1.85
State Ownership 0.003 0.003 0.007 State Ownership 0.003 0.012 **
0.58 0.63 1.11 0.57 2.26
ADR –0.030 *** –0.030 *** –0.021 *** ADR –0.030 *** –0.029 ***
–5.87 –5.86 –3.58 –5.87 –5.09
Latin –0.031 *** All Time Latin –0.031 ***
–5.31 –5.20
Latinp –0.024 ** Former Latin 0.007 *
–1.94 1.34
Latinb –0.033 ***
–5.08
Two Tiers 0.027 **
1.66
Anglo-Saxon 0.016
Downloaded by [Carlos Alves] at 01:47 12 October 2013

0.97
L1 0.028 ***
3.57
L2 0.000
0.03
New Market 0.037 ***
4.55
F-statistic 25.57 21.41 7.57 F-Statistic 25.13 8.13
N 482 482 482 N 480 480

Notes: (i) Dependent variable is the level of discretionary accruals, computed for each firm and year. Independent variables are described
in the text; (ii) Equations were estimated by Panel estimated generalized least squares (EGLS) (cross-sectional weights); (iii) ***, ** and
* denote statistical significance at 1%, 5% and 10% levels, respectively.

compared between the two groups of companies, no sig-
nificant overall differences were detected (Panel B.I),
although the median was higher in the case of companies
with State ownership (Panel B.II). The compatibility
between these two findings can be particularly noticed
by observing that the maximum and 75th percentile results
were higher for non-State-owned compared to State-
owned companies (see proportions in Q1 in Panel B.III).
Thus, there were more non-State-owned companies at the
top than companies with State ownership. In short, on
average, companies with State ownership were not distin-
guished from the others, with the top levels of discretion-
ary accruals being observed predominantly in other
companies.
Panel data regression analysis
We performed regression analyses to confirm the univari-
ate results. We estimated our model by Panel estimated
generalized least squares (EGLS) (cross-sectional
weights), taking advantage of the pooled characteristics
of our sample. The dependent variable was the level of
discretionary accruals in all regressions reported in
Table 4. In these regressions, we controlled for several
governance characteristics but not for the other firms’
characteristics. Cross-sectional differences were consid-
ered in the calculation of the discretionary accruals. At
least in Panel II, where we analysed companies that moved
away from the Latin model, the remaining characteristics
of the firms were controlled for, given that any firm
behaved as a controller of itself.
Several independent variables were assigned. The
Country variable was assigned a value of 1 for a
Portuguese company and 0 for a Brazilian company. The
ADR variable was assigned a value of 1 when there was a
dual listing (in either Portugal or Brazil and in the US) and
0 otherwise. The variable State Ownership was assigned a
value of 1 when the State (i.e. Portugal or Brazil) had a
qualifying holding and 0 otherwise.
Other dummy variables referred to the type of govern-
ance model adopted. The variable Latin assumed a value
of 1 if the company adopted the Latin model and 0
otherwise. LatinP (or LatinB) assumed a value of 1 if
the company was Portuguese (or Brazilian) and
adopted the Latin model, and 0 otherwise, with
 1672
Latin = LatinP + LatinB. Variables Two Tiers and Anglo-
Saxon identified Portuguese companies that adopted the
Continental or the Anglo-Saxon model, respectively.
Dummy variables L1, L2 and New Market were equal to
1 if the Brazilian companies adopted the Level 1, Level 2
or New Market model, respectively, and 0 otherwise.
Two variables were built to signal changes in the
governance model. The variable All Time Latin took a
value of 1 if the company had always maintained the
Latin model and 0 otherwise. The variable Former Latin
took a value of 1 if the company had previously adopted
the Latin model and now adopts a different model and 0
otherwise.4
Equation 1 unequivocally reiterates two findings from
the univariate analysis: namely, companies adopting the
Latin model had lower indices of earnings management
(coefficient –0.031), and dual listing was inseparable from
a lower level of discretionary accruals (coefficient –
0.030). Equation 2 verifies that these findings were true
Downloaded by [Carlos Alves] at 01:47 12 October 2013
for both Brazilian and Portuguese companies. This result
is more robust than the one in Table 1, where the result for
Portuguese companies was not statistically significant.
Equation 3 shows that the highest level of earnings man-
agement against the Latin model was visible in all of the
‘Other models’ because the coefficients of the variables
Two Tiers, Anglo-Saxon, L1, L2 and New Market were all
positive. However, in the case of the variables Anglo-
Saxon and L2, we cannot reject the hypothesis that these
coefficients are zero. We conclude that Equations 1–3
confirm the assertion that companies using the Latin
model had lower levels of discretionary accruals than
those using Other models.
Equation 4 confirms that companies that have always
used the Latin model had lower levels of earnings manage-
ment than other companies. Equation 5 indicates that
switching from the Latin model to another model did not
entail a reduction of discretionary accruals. Rather, com-
panies that switched models changed to have higher levels
of earnings management.
Robustness analysis
We performed robustness analyses to confirm our regres-
sion conclusions.5 To control for the impact of the busi-
ness cycle, the five equations reported in Table 4 were
regressed, including time-dummy variables. This step is
equivalent to including time-fixed effects. Our results did
not change with this analysis.6 All of the significant vari-
ables remained significant, and the signals of the coeffi-
cients remained exactly the same as in Table 4.
4
In our sample, no company has changed from another model to the Latin model, and only one Portuguese company originally used a
model that was not the Latin model.
5
We thank an anonymous referee for this suggestion.
6
To preserve space, the results of the robustness analysis are not reported but are available upon request.
C. F. Alves and E. F. R. Vicente
To confirm the robustness of the results, we per-
formed quartile regressions (which allow different coef-
ficients for different quartiles). Again, our results did
not change with this analysis. In Equation 1, the coeffi-
cients of the ADR and Latin variables were negative in
all quartile regressions and, except for the coefficient of
ADR for the third quartile (75th percentile) regression,
they were all statistically significant. Regarding the
Country variable (Equation 2), we again found more
robust evidence for Brazil than for Portugal. We found
negative and significant coefficients for the All Time
Latin variable in all regressions (Equation 4), confirm-
ing that companies that used the Latin model all the
time had lower discretionary accruals than other com-
panies. The positive effect of the Former Latin variable
(Equation 5) reported in Table 4 was due to companies
with the top levels of discretionary accruals, given that
its coefficient was only positive and significant in the
third quartile regression.
V. Conclusion
Existing studies of earnings management have been
based on companies whose governance models corre-
spond to the one-tier Anglo-Saxon and the two-tier
Continental models. However, some countries tradition-
ally adopt other governance models, such as the so-called
Latin model that prevails in Portugal and Brazil. The
main difference between the Latin model and other mod-
els is that the Latin model contains a specific and inde-
pendent audit board, rather than an audit committee. To
date, no study has addressed whether the internationally
dominant models induce higher quality financial infor-
mation than the Latin model. This article aims to bridge
this gap by answering the following three major research
questions: Do companies using the Latin model of cor-
porate governance perform worse in terms of preventing
earnings management compared to companies using
other models? Is the Latin model more likely to be
abandoned by companies with higher or lower levels of
discretionary accruals? Does a company’s discretionary
accrual level decrease after it switches from the Latin
model to another model?
Based on our findings, we can conclude that companies
adopting theoretically ‘more robust’ models do not have
lower discretionary accruals than those achieved by com-
panies adopting the Latin model. Rather, these other com-
panies generally have higher discretionary accruals than
 Does the Latin model of corporate governance perform worse?
Latin model companies. Companies that adopt the Latin
model do not perform worse than other companies with
regards to the prevention of earnings management prac-
tices. Companies that abandon the Latin model are those
with above-average levels of discretionary accruals, but
not those with extremely high earnings management prac-
tices. Moreover, the switch does not result in a generalized
reduction of earnings management practices. Only firms
that already had lower earnings management levels before
switching showed obviously reduced discretionary
accruals after switching.
Finally, we conclude that companies that are dual-listed
in the United States have lower levels of management than
non-dual-listed companies, which may be due to the fact
that they are subject to both US rules and double scrutiny.
Companies in which the State is a qualified shareholder
cannot be distinguished from non-State-owned compa-
nies, especially with regard to the level of earnings man-
agement. Thus, there is no longer the concern that political
Downloaded by [Carlos Alves] at 01:47 12 October 2013
influence could make such companies achieve higher
levels of earnings management compared to other
companies.
The findings of this article have regulatory implications
because they show that the more robust models may not
perform – in terms of quality improvement of financial
reporting – as expected by legislators and regulators.
Thus, a new challenge is created: that of investigating
the reasons why this happens (which we will try to answer
in future research). However, the findings also show that
more than the model, it is the people and actual govern-
ance practices that deserve the attention of legislators and
regulators.
Funding
CEF.UP (Research Center in Economics and Finance) is
supported by FCT (Foundation for Science and
Technology) through POCTI (Operational Program for
Science, Technology and Innovation) of the QCAIII
(Community Support Framework), which is financed by
the European Regional Development Fund (ERDF) and
Portuguese funds.
1673
References
Alves, C. and Mendes, V. (2004) Corporate governance policy
and company performance: the case of Portugal, Corporate
Governance: An International Review, 12, 290–301.
Alves, C. and Mendes, V. (2009) The Portuguese corporate
governance codes as a factor of changes in rules and
practices, in Codes of Good Governance around the
World, (Eds.) J. Félix and L. Iturriaga, Nova Publisher,
New York, NY, pp. 317–51.
Bartov, E., Gul, F. and Tsui, J. (2000) Discretionary-accruals
models and audit qualifications, Journal of Accounting
and Economics, 30, 421–52.
Beasley, M. (1996) An empirical analysis of the relation between
the boards of directors and financial statement fraud,
Accounting Review, 71, 443–65.
Chan, K., Chan, L., Jegadeesh, N. et al. (2006) Earnings quality
and stock returns, Journal of Business, 79, 1041–82.
CMVM (2010) Annual Report on the Corporate Governance of
Listed Companies in Portugal. Available at www.cmvm.pt
(accessed 17 September 2013).
Dechow, P., Sloan, R. and Sweeny, A. (1995) Detecting earnings
management, Accounting Review, 70, 193–225.
Jones, J. (1991) Earnings management during import relief inves-
tigations, Journal of Accounting Research, 29, 193–228.
Klein, A. (2002) Audit committee, board of director character-
istics and earnings management, Journal of Accounting and
Economics, 33, 375–400.
Madhogarhia, P., Sutton, N. and Kohers, T. (2009) Earnings
management practices among growth and value firms,
Applied Financial Economics, 19, 1767–78.
Osma, B. and Noguer, A. (2007) The effect of the board compo-
sition and its monitoring committees on earnings manage-
ment: evidence from Spain, Corporate Governance: An
International Review, 15, 1413–28.
Peasnell, K., Pope, P. and Young, S. (2005) Board monitoring
and earnings management: do outside directors influence
abnormal accruals?, Journal of Business Finance and
Accounting, 32, 1311–46.
Piot, C. and Janin, R. (2007) External auditors, audit committees
and earnings management in France, European Accounting
Review, 16, 429–54.
Silva, A., Vitorino, A., Alves, C. et al. (2006) Livro Branco
Sobre Corporate Governance Em Portugal, IPCG, Lisboa.
Sloan, R. (1996) Do stock prices fully reflect information in
accruals and cash flows about future earnings?,
Accounting Review, 71, 289–315.
Warfield, T., Wild, J. and Wild, K. (1999) Managerial ownership,
accounting choices and informativeness of earnings,
Journal of Accounting and Economics, 20, 61–91.
Xie, B., Davidson III, W. and Dadalt, P. (2003) Earnings manage-
ment and corporate governance: the roles of the board and the
audit committee, Journal of Corporate Finance, 9, 295–316.