Governance in Action: How Board Characteristics Mitigate Cash Flow Classification Shifting? The Moderating Role of Financial Constraints

Abstract

Purpose: We empirically examine the impact of board characteristics (BCs) on a novel form of classification shifting (CS) using cash flows among Indian listed firms. Additionally, we aim to investigate whether the financial constraints influence this nexus.

Methodology: We used a dataset consisting of 1602 firm-year observations from 2013 to 2022 to achieve these objectives. Employing a fixed-effect panel-data regression approach, our findings reveal compelling evidence that Indian firms actively engage in cash flow classification shifting (CS), strategically reallocating cash flow items across different reporting activities.

Findings: This result underscores the need for enhanced governance mechanisms to ensure financial reporting transparency. In terms of BCs, we found that board size, board gender diversity, and board independence are negatively associated with CS, highlighting their effectiveness in curbing activities like CS and improving the financial reporting quality. Furthermore, the findings reveal that financial constraint moderates the association between BCs and CS, as board independence and women directors are ineffective to curb CS, when Indian firms are facing financial constraints; however, board meetings positively impact cash-flow CS. The main results remain robust after employing GMM estimation and an alternative proxy of financial constraint.

Originality: Our study offers significant implications for policymakers and regulators, particularly emphasizing the critical role of female board members and the presence of independent directors in fostering transparent and ethical corporate practices.