This study contributes to the literature on the role of the board by investigating the effect of board composition on the practice of earnings management in Canada. We find that earnings are managed upward to avoid reporting losses and earnings declines. While outside directors, as a whole, do not reduce abnormal accruals, directors from financial intermediaries reduce earnings management, and the board representation of active institutional shareholders reduces it further. We do not find that monitoring of abnormal accruals by outside directors, as a whole, or by directors from financial institutions is more effective after the issuance of the Toronto Stock Exchange's Corporate Governance Guidelines of 1994. Finally, we do not find that earnings management decreases with the average tenure of outside directors as board members of the firm, either. Our findings suggest that adding outside directors to the board may not achieve improvement in governance practices by itself, especially in jurisdictions where ownership is highly concentrated and the outside directors' labor market may not be well developed.

Using the quarterly Compustat files, we present empirical findings that business capital investment is significantly higher in the fourth quarter than in other quarters. Even after controlling for business capital investment determinants, we find that the fourth quarter capital investment is significantly larger but less sensitive to investment opportunities than other quarters' capital investment. This phenomenon is more evident for firms with larger cash holdings than for firms with smaller cash holdings, for larger firms than for smaller firms, and for diversified firms than for stand-alone firms. Our findings suggest a high level of agency costs in corporate investment decisions.

We compare the investment–cash flow sensitivity of Korean chaebols (conglomerates) and non-chaebol firms. We show that investment–cash flow sensitivity is low and insignificant for chaebol firms but is high and significant for non-chaebol firms. On the other hand, a chaebol firm's investment is significantly related to the growth opportunities but that of a non-chaebol firm is not. A chaebol firm's investment is significantly affected by the cash flow of other firms within the same chaebol even though they are independent legal entities. With these findings, we argue that there is an internal capital market in a chaebol and the internal capital market reduces the financing constraints of the chaebol. However, the operation of the internal capital market does not improve the efficiency of allocation of scarce funds in the Korean economy since we find that chaebols invest more than non-chaebol firms despite their relatively poor growth opportunities.