Codetermination and aggressive reporting: Audit committee employee representation, tax aggressiveness, and earnings management

Abstract

This study uses a unique dataset from listed German companies that helps identify a granular measure of board-level codetermination to examine whether board-level codetermination (inclusion of employee representatives on the board) reduces aggressive financial and tax reporting, i.e., tax aggressiveness and earnings management. To the extent codetermination allows for effective employee monitoring of management, then it should be negatively associated with tax and financial reporting aggressiveness because prior research hypothesizes that employees prefer lower tax aggressiveness and less earnings management. Our analysis also highlights the mechanisms through which employees can monitor and influence firms’ decisions and outcomes. We find employee representation on audit committees is the most consistently influential codetermination mechanism associated with reduced tax aggressiveness and earnings management. We contribute to prior and current discussions of stronger employee rights and influences on management decisions from a board-level perspective.