Does the board of directors and (non)-executives’ ownership mitigate interest payment classification shifting? UK Evidence

We investigate whether the board of directors and stock ownership by outside directors and executives may limit interest payment classification shifting within the statement of cash flows. We find that the interest payment classification shifting is less prevalent in UK firms with high-quality internal governance, demonstrating that effective internal governance may serve as a substitute for rules-based accounting standards. While we find governance mechanisms play a crucial role in mitigating such practice in both distressed and non-distressed firms, our finding is more pronounced in non-distressed firms. We also find that there is an inverted U-shaped relationship between the board independence, managerial and independent directors’ stock ownership, and the classification shifting of interest payment; indeed, it is premature to propose that independent and stock ownership can serve as an effective mechanism in mitigating managerial opportunism in all cases, and indeed, there should be optimal independent director and ownership thresholds before which caution would be required to ensure that managers remain focused on maximizing shareholder value.