Exploring the nexus between external corporate governance mechanisms and earnings quality: evidence from Pakistan’s stock exchange

Purpose This study aims to investigate the nexus between external corporate governance mechanisms and firms reported earnings quality. Audit quality and ownership structure were used to measure external corporate governance mechanisms. In addition, the ownership structure is further divided into foreign and institutional ownership. Design/methodology/approach To test the proposed hypotheses, the study used the generalized method of moments on a sample of Pakistani listed firms from 2008 to 2023. Furthermore, the study used the modified Jones model to measure earnings quality, as introduced by Kothari et al. (2005). Findings The findings reveal that audit quality and foreign ownership strongly predict firms’ reported earnings quality, while institutional ownership has a significant relationship with financial reporting earnings quality, albeit only at a 10% significance level. The study offers robust evidence indicating that external auditor quality, foreign ownership and institutional ownership play pivotal roles in alleviating agency conflicts, thus, exerting a notable and positive influence on earnings quality within the Pakistani context. Originality/value This study contributes to a reliable and relevant understanding of the determinants of earnings quality in emerging economies like Pakistan. Such insights are crucial for investors to properly understand the quality of earnings in listed firms on the Pakistani stock exchange and positively enhance their ability to make informed economic decisions. Furthermore, a deeper understanding of earnings quality provides valuable insights for regulators to bolster stakeholder trust and confidence in the financial reporting process.