Summary and conclusions
This paper investigates whether business group affiliations’ ownership structure affects the quality of earnings reporting using data from South Korea. Existing theories provide two competing hypotheses about the impact of group ownership structure on the quality of financial reporting. The entrenchment effect hypothesis predicts the complex ownership structure and self-dealing internal market in group firms may create greater incentives to managers in business groups to manage earnings for their private benefits. Conversely, however, group firms may report earnings of higher quality due to the reforms and the increasing pressure by financial statement users for higher earnings quality report.
Using a large sample of firms listed on the Korean stock exchange over a period from 1993 to 2007, we found that business group affiliation is significantly associated with higher earnings quality. The result suggests that group firms report greater earnings quality than non-group firms because the demand for higher earnings quality increased after the Asian crisis. Moreover, the result indicates that chaebols improved their transparency due to strong monitoring mechanisms introduced by the government. Thus, group firms’ owners have actively engaged in monitoring managers’ opportunistic behaviors to manage earnings to protect their investment and reputation. We also found that the ownership disparities between control and cash flow rights and family ownership are negatively associated with earnings quality. The results suggest that group firms with high ownership disparity are less transparent and mask their expropriation from such firms, and family owners in firms may have greater incentives to be engaged in earnings management for their private benefit. The results are also robust to alternative measures of earnings quality, group rank and endogeneity issue related to group membership.
