Leverage, Corporate Governance and Real Earnings Managem ent: Evidence from Korean Market

Abstract

This study examines how corporate governance (CG) and leverage simultaneously influence real earnings management (REM). Methodology: We employed CG score (CGS), total, short-term, and long-term debt ratios as independent variables, and REM metrics as dependent variables. We include ordinary least-squares (OLS) panel data regressions, residual test, and interaction analysis in our study. Findings: While a significant positive relationship existed between leverage and REM, CG had a negative effect on real manipulations. Our results from the interaction analysis and residual test show that CG is a key player in explaining the relationship between leverage and REM. We also find that firms with a low-level of CG were more likely to conduct REM activities than those with a high-level CG. Research limitations/implications: These results imply that the reduction in opportunistic behavior of managers in the presence of strong CG could decrease the leverage of firms and REM activities and improve the quality of their earnings. Moreover, shareholder rights and audit organizations were the prominent CG characteristics influencing REM activities, as they enforce additional monitoring of financial reporting quality and increase audit standards. CG strategies mitigate the corporate corruption scandals through the adoption of high-quality accounting and financial norms in reporting and management. Thus, executives decrease their incentives to conduct REM activities and leverage cannot be used freely as a mechanism to manipulate earnings, given firms' leverage position is audited and reviewed by the financial committee in firms with strong CG. For future research, the authors suggest including the degree of leverage as a disaggregation sample and adding the degree of cost stickiness. Originality/value: Several studies have investigated either the relationship between (1) REM and leverage, or (2) REM and CG, including leverage as a control variable. Our study, extends this bilateral relationship to simultaneous relationship between leverage, CG, and REM. Moreover, we investigate the predominant CG characteristics that influence the association among leverage and REM. We conduct interaction analysis and residual effect to investigate if CG should be considered as a determinant variable in the recurrence of REM activities of managers. We include firms with high-and low-levels of CG to show which firms are leveraged.

Earnings Management Practices of Family and Non-Family Entities

“…large companies face more significant challenges in maintaining the company's reputation. The company's actions are being scrutinized by stakeholders (Lassoued et al, 2018;Tulcanaza-Prieto et al, 2020;Wuryani, 2012), thus causing the family entities more restricted in practicing accrual approaches. Therefore, family entities begin to turn into a real form of earnings management, as it is more hidden from detection by auditors or other parties (Hewitt et al, 2020;Zang, 2012).…”

“…From the analysis of SIZE as a moderating variable, it is understood that although family firms prefer the accrual form of earnings management, the firm size weakens the preference of the accrual approach. The larger the business, the more intense the entities is being observed by interested parties (Lassoued et al, 2018;Tulcanaza-Prieto et al, 2020;Wuryani, 2012), which causes family entities to be limited to practice accrual approach.…”

Organizational Culture and Corporate Performance in the Ecuadorian Environment

“…Therefore, we suggest that external and internal factors that influence firm performance should be excluded in order to increase the model's power. Moreover, it is necessary to include the characteristics of the studied firms, such as age, property (public or private), degree of corporate governance (Tulcanaza-Prieto et al 2020b), and social environment in future analysis, in order to evidence the relationship between organizational culture, firm performance, and the specific features of firms. Finally, although the study's purpose was to analyze organizational performance from non-financial indicators, it is important to test the model using financial performance measures (return on assets, return on equity, sales growth, Tobin's Q), since the study only includes non-financial performance proxies.…”

The Effect of Corporate Governance on the Degree of Agency Cost in the Korean Market

“…Most chaebols are pyramidal business groups in which families retain control over many assets using intercorporate shareholding. This ownership structure makes the financial and accounting standards more flexible, creates deviations in cash flow and earnings (Tulcanaza-Prieto and Lee 2022;Tulcanaza-Prieto et al 2020), increases information asymmetry between parties, promotes managers' opportunistic behavior, and increases the control and power of shareholders decisions; consequently, AC disputes between majority and minority shareholders are aggravated. Moreover, the term CG in Korea is associated with the intercorporate control structure of a business group from the perspective of controlling families, which generates an inherent agency problem among controlling shareholders, minority shareholders, and managers.…”