The effect of control-ownership disparity on earnings management: evidence from Korean large business groups

Abstract

This study examines the difference in the use of earnings management at family-controlled firms belonging to Korean large business groups (chaebol) versus non-chaebol firms belonging to Korean large business groups from 2002 to 2016. Firms belonging to large business groups are subject to similar regulations by authorities. This study also tests whether a divergence between voting rights and cash flow rights affects earnings management by controlling shareholders. This study examines both accrual-based earnings management (AEM) and real-activities earnings management (REM), using two measures of accrual-based earnings management and three measures of real-activities earnings management. This study finds that chaebol firms have better earnings quality compared to non-chaebol when an earnings quality measure is used as an AEM proxy. However, there is no significant difference between chaebol and non-chaebol firms when a second AEM proxy, measuring discretionary accruals, is employed. These mixed results indicate that there is no difference between family-controlled firms (chaebol) and non-family firms (non-chaebol) in the use of accrual-based earnings management. Second, this paper provides evidence that there is no significant difference between chaebol firms and non-chaebol firms with respect to all three measures of real-activities earnings management. This study finds stronger evidence of overproduction as a means of real-activities earnings management at a subsample of firms in manufacturing industries, compared with the full sample containing firms in both manufacturing and non-manufacturing industries. This study shows that a control-ownership disparity by controlling insiders of large business groups does not have an impact on accrual-based earnings management or real-activities earnings management. This is because a variety of regulations imposed on large business group make the use of earnings management costly regardless of the presence of a control-ownership wedge. In additional analyses, this paper finds that chaebol firms with greater control-ownership disparity are associated with poor earnings quality. Lastly, this study finds that chaebol firms engage less in overproduction as a means of real-activities earnings management, as the families which control the chaebol have a greater disparity between control rights and ownership rights.