Governance Gambit: The Unforeseen Impact on Disclosure Quality

Extensive research in earnings management has focused on understanding managerial bias and its impact on disclosure quality. This study extends this literature by introducing a model of earnings management with dual oversight mechanisms. The first is internal supervision, such as internal controls and audit committees, which operates before reports are released. The second is external supervision, such as SEC investigations and litigation, which occurs after they are released. The model shows that although stronger internal supervision reduces managerial bias, it may paradoxically reduce the informativeness of disclosures for investors. In addition, internal and external penalties interact; internal penalties enhance the effectiveness of internal supervision, whereas external penalties weaken it. Together, these results show that disclosure quality depends on the joint operation of supervisory tools and that strengthening internal controls in isolation may not improve outcomes.