📈 economics

The Moderating Role of Optimal Board Size in the Relationship Between Earnings Management and Firm Performance in GCC Countries

Based on a study of 188 listed companies in GCC countries from 2017 to 2021, the research finds that while earnings management negatively impacts firm performance, having an optimal board size of at least nine members not only enhances performance directly but also mitigates the adverse effects of earnings management.

Original authors: Sulaiman Alsudays, Ahnaf Ali Alsmady, Nouf Binhadab, Sheela Sundarasen

Published 2026-09-22

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CC BY 4.0

Original authors: Sulaiman Alsudays, Ahnaf Ali Alsmady, Nouf Binhadab, Sheela Sundarasen

Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

In the world of business, a company is often described as a machine where the owners, who provide the capital, hire managers to run the daily operations. This arrangement creates a natural tension: the people running the show might make decisions that benefit themselves rather than the owners. To keep this relationship healthy, companies rely on a board of directors, a group of people elected to watch over the managers and ensure they act in the best interest of the shareholders. One of the most critical tasks for these boards is to prevent "earnings management," a practice where managers tweak financial reports to make the company look more profitable than it truly is. While this might boost the company's image for a short time, it often damages the firm's long-term health and value. The question of how big a board should be to do its job effectively has long been debated. Some argue that a small group makes decisions faster and communicates better, while others believe a larger group brings more diverse skills and stronger oversight. Finding the right balance is crucial, especially in the Gulf Cooperation Council (GCC) region, where business structures and cultural norms differ significantly from those in Western economies.

A team of researchers set out to solve this puzzle by examining data from 188 listed companies across six GCC countries: Saudi Arabia, the United Arab Emirates, Oman, Kuwait, Qatar, and Bahrain. They analyzed financial records from 2017 to 2021, a period that included the economic disruptions caused by the global pandemic, to see how the size of a company's board influenced its performance and its tendency to manipulate financial numbers. The study focused on a specific threshold: nine members. The researchers wanted to know if having more than nine directors made a difference compared to having fewer, and whether the size of the board could act as a shield against the negative effects of earnings manipulation.

The investigation revealed a clear pattern. Companies with boards larger than nine members tended to perform better financially. In contrast, those with smaller boards, specifically those with fewer than nine members, showed weaker performance. This suggests that in the complex business environment of the Gulf, a larger group of directors provides the necessary breadth of experience and monitoring power to guide a company effectively. The study also confirmed that when managers engaged in earnings management, the company's performance suffered. However, the size of the board changed how severe this damage was. When a company had a large board of more than nine members, the negative impact of financial manipulation was significantly weakened. The larger group acted as a stronger check on management, dampening the harm that skewed financial reports could cause. Conversely, smaller boards were less effective at this, allowing the negative effects of manipulation to hit the company's performance harder.

To ensure these findings were solid, the researchers tested their results against other factors, such as the presence of women on the board, the involvement of government representatives, and whether the CEO also served as the head of the board. They found that having diverse representation and independent oversight further improved company performance, while combining the roles of CEO and board chair tended to weaken it. Even after using advanced statistical methods to rule out hidden variables or reverse causes, the core message remained the same. The data strongly suggests that for companies in this region, a board size of at least nine members is not just a number, but a functional requirement for effective governance. It appears that the benefits of having a wide range of expertise and a robust monitoring system outweigh the potential downsides of coordinating a larger group.

These findings offer a practical roadmap for regulators and business leaders in the Gulf. Rather than leaving board size to chance or tradition, the evidence points toward encouraging a minimum of nine directors for listed firms. This structure seems to provide the optimal mix of oversight and expertise needed to keep managers honest and companies thriving. By adopting this approach, firms can better protect themselves against the risks of financial manipulation and ensure that their long-term value is preserved. The study concludes that in the unique institutional landscape of the GCC, a larger board is not a burden, but a vital tool for maintaining trust and driving success.

Technical Summary: The Moderating Role of Optimal Board Size in the Relationship Between Earnings Management and Firm Performance in GCC Countries

1. Problem Statement and Research Gap
Corporate governance (CG) is widely recognized as a mechanism to mitigate agency problems arising from the separation of ownership and control. While existing literature extensively documents the direct effects of CG mechanisms on firm performance (CP) and the detrimental impact of earnings management (EM) on CP, there is limited empirical evidence regarding the moderating role of board size (BS) in the relationship between EM and CP. Specifically, the literature lacks consensus on whether smaller or larger boards are more effective in emerging markets, and no prior study has tested a specific "optimal" board size threshold (e.g., nine members) within the Gulf Cooperation Council (GCC) context. Furthermore, the interplay between board size and EM as a governance mechanism to mitigate agency costs in GCC countries remains underexplored.

2. Methodology

Sample and Data: The study utilizes a panel dataset of 188 listed non-financial companies across six GCC countries (Saudi Arabia, UAE, Oman, Kuwait, Qatar, and Bahrain) covering the period 2017–2021. This yields 846 firm-year observations. Financial and insurance firms were excluded due to distinct regulatory frameworks.
Variables:
- Dependent Variable: Company Performance (CP), measured by Return on Equity (ROE).
- Independent Variable: Earnings Management (EM), measured using the performance-matched Modified Jones Model (Kothari et al., 2005) to estimate discretionary accruals.
- Moderator: Board Size (BS). The study defines BS as the total number of directors. Crucially, it introduces binary variables based on a threshold of nine members (derived from Lipton and Lorsch [34] and the sample median/mode): $D1$ (BS > 9) and $D2$ (BS < 9).
- Controls: Firm size (log of total assets), leverage, sales growth, revenue volatility, and a COVID-19 dummy variable.
- Extended Controls: In robustness checks, the model includes gender diversity (female/male directors), government directors, board independence, and CEO duality.
Estimation Strategy: The primary analysis employs a Generalized Least Squares (GLS) random-effects regression model, selected via the Hausman test.
- Model 1: Tests the direct effects of BS and EM on CP.
- Model 2: Tests the moderating effect by including interaction terms ( $BS \times EM$ , $D1 \times EM$ , $D2 \times EM$ ).
Robustness and Endogeneity Checks:
- 2SLS Estimation: Used to address potential endogeneity in board composition variables (gender, government representation).
- System GMM: Employed to address reverse causality and omitted variable bias, utilizing a two-step estimator with a collapsed instrument matrix.
- Non-linearity Test: A squared board size term ( $BS^2$ ) was added to test for non-linear relationships.
- Diagnostic Tests: Variance Inflation Factor (VIF) and Durbin-Watson tests confirmed no multicollinearity or autocorrelation issues.

3. Key Results

Direct Effects:
- Board Size: There is a significant positive association between board size and firm performance. Specifically, boards with more than nine members ( $D1$ ) show a positive and significant impact on CP, whereas boards with fewer than nine members ( $D2$ ) show a negative association.
- Earnings Management: EM is negatively and significantly associated with CP, confirming that discretionary accruals erode firm value.
Moderating Effects:
- Board size significantly moderates the relationship between EM and CP.
- Large Boards ( $>9$ ): The interaction term ( $D1 \times EM$ ) is positive and significant. This indicates that larger boards weaken the negative impact of EM on performance, acting as an effective governance mechanism to constrain opportunistic behavior.
- Small Boards ( $<9$ ): The interaction term ( $D2 \times EM$ ) is negative and significant, suggesting that smaller boards fail to mitigate, and may even intensify, the adverse effects of EM on performance.
Extended Analysis:
- Board gender diversity (both male and female counts), government representation, and board independence are positively associated with CP.
- CEO duality is negatively associated with CP.
Robustness: The System GMM and 2SLS estimations confirmed that the main findings are not driven by endogeneity. The non-linear test ( $BS^2$ ) was insignificant, supporting the use of the nine-member threshold as a more appropriate specification than a quadratic curve for this sample.

4. Contributions and Significance
The paper claims three primary contributions to the literature:

Empirical Evidence on Optimal Threshold: It provides the first empirical evidence in the GCC region distinguishing between small and large boards using a specific threshold of nine members. It identifies this threshold as the point where the trade-off between monitoring benefits and coordination costs is optimized for GCC firms.
Novel Moderating Perspective: It is the first study to demonstrate that larger boards (specifically those exceeding nine members) positively moderate the EM-CP relationship. This offers a new perspective on how board structure can serve as a mechanism to mitigate agency problems by weakening the negative consequences of earnings management.
Integrated Governance Approach: The study extends the analysis by incorporating a comprehensive set of internal governance variables (gender diversity, government directors, independence, CEO duality) simultaneously, offering a more holistic view of governance in emerging markets.

5. Practical Implications
Based on the findings, the authors suggest that regulators in GCC countries should consider encouraging or mandating a minimum board size of at least nine members for listed firms. For firms, maintaining a board size of approximately nine to eleven members is recommended to balance expertise, oversight, and decision-making efficiency. Additionally, firms are advised to utilize board structure as a strategic governance tool to mitigate the adverse effects of earnings management and enhance long-term performance. The findings also support promoting board diversity and separating the roles of CEO and chairperson.

6. Limitations and Future Directions
The study acknowledges its focus on the GCC region, which has unique cultural and institutional characteristics. Future research is suggested to expand the sample to the broader Middle East and North Africa (MENA) region and to conduct comparative analyses between MENA countries and developed Western economies to enhance the generalizability of the findings.

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