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The impact of ownership structure on earnings quality: the case of South Korea

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Abstract

This paper investigates the impact of business group ownership structure on the quality of earnings reporting using data from South Korea. In addition, we investigate the impact of ownership disparity and family ownership on earnings quality reporting. Using a self-constructed earnings quality index as a measure of earnings quality, we found that business group ownership structure is significantly associated with higher earnings quality. The result suggests that strong monitoring mechanisms introduced by the government, which are necessary for credibility in external financial markets and beneficial to business group reputation, led to increased transparency in earnings reports. We also found that disparity in ownership between control and cash flow rights in firms, as well as family ownership in group firms, was both associated with lower earnings quality.

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Notes

  1. Khanna and Rivkin (2001) define the business group as "a collection of firms which, though legally independent, are bound together by a constellation of formal and informal ties and are accustomed to taking coordinated actions."

  2. We discussed chaebol reforms and the reforms introduced by the government in more detail in “Group firms and earnings quality” section.

  3. Prior studies indicated that market forces (e.g., capital market development) play a role in shaping financial reporting. Firms report higher earnings quality due to higher market demand for higher-quality earnings (Coelho et al. 2017).

  4. For example, Chairman Lee Kun-Hee (Lee) of the Samsung Group, one of the largest chaebols in Korea, controls Samsung Electronics. Although Lee is neither chairman of the board nor CEO of any of the group’s main affiliates, he controls these companies indirectly because of Samsung Group’s vast cross-shareholdings (Murillo and Sung 2013; Jung and Kwon 2002).

  5. Coelho et al. (2017) note that to have access to external sources of funds firms have to credibly commit to maintain a reasonable flow of information in order to facilitate monitoring by boards, auditors and regulators.

  6. Data source: groupopni.ftc.go.kr.

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Author information

Authors and Affiliations

  1. Zayed University College of Business, P.O. Box 144354, Abu Dhabi, United Arab Emirates

    Abiot Tessema & Moo Sung Kim

  2. Zayed University College of Business, P.O. Box 144354, Dubai, United Arab Emirates

    Jagadish Dandu

Authors
  1. Abiot Tessema
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  2. Moo Sung Kim
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  3. Jagadish Dandu
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Corresponding author

Correspondence to Abiot Tessema.

Appendix 1

Appendix 1

Variables definition

Variables

Definition

Earnings quality index (EQA)

An index obtained from four earnings quality attributes—accrual quality, persistence, predictability, and smoothness. The higher (lower) value indicates higher (lower) earnings quality. Details for calculating the accrual quality are provided in “Results” section

Accrual quality

Measure of accrual quality using the Dechow and Dichev (2002) measurement. The higher (lower) value indicates more (less) corporate transparency. Details for calculating the accrual quality are provided in “Results” section

Persistence

Measure of earnings persistence following Francis et al. (2004). The higher (lower) value indicates more (less) corporate transparency. Details for calculating the persistence are provided in “Results” section

Predictability

Measure of earnings predictability following Francis et al. (2004). The higher (lower) value indicates more (less) corporate transparency. Details for calculating the persistence are provided in “Results” section

Smoothness

Measure of earnings smoothness following Francis et al. (2004). The higher (lower) value indicates more (less) corporate transparency. Details for calculating the persistence are provided in “Results” section

Group-related variables

Group

A dummy variable to indicate whether a firm belongs to one of the 30 largest business groups in South Korea. The Korea Fair Trade Commission (KFTC) updates the list of the 30 largest business groups annually. Alternative group definitions will be used as a robustness test later

Ownership disparity (OWNER_DIS)

The disparity between control ownership and cash flow ownership of the controlling shareholder in a group firm

Firm-specific variables

Family

The percentage of common equity ownership held by the largest shareholder family

Domestic institution (DIN)

The percentage of common equity ownership held by domestic financial institutions or institutional investors

Foreign institution (FIN)

The percentage of common equity ownership held by foreign financial institutions or institutional investors

Government (GOV)

The percentage of common equity ownership held by government or government agencies

Firm age (FAG)

The number of years since a firm’s founding date

Firm size (FSIZE)

The natural log of the total assets of a firm in South Korean won

Debt ratio (DR)

The ratio of total debts to total assets of a firm

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Tessema, A., Kim, M.S. & Dandu, J. The impact of ownership structure on earnings quality: the case of South Korea. Int J Discl Gov 15, 129–141 (2018). https://doi.org/10.1057/s41310-018-0039-x

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