Managerial Ownership and Informativeness of Earnings : Evidence from Thailand

This paper examines the relation between managerial ownership and the quality of accounting information in an emerging market. It is hypothesized that the relation between managerial ownership and earnings’ explanatory power of returns is negative and different from that documented in developed markets due to a unique institutional setting, leading to relatively high agency conflicts and information asymmetry. However, the relation between managerial ownership and earning informativeness becomes positive under financial distress because of the hypothesized effects of creditor monitoring, minority interest, and management’s desire to reduce further intervention. In addition, managerial ownership is positively related to the use of discretionary accruals. The finding is consistent with the notion that ownership structure affects the quality of accounting information. Corresponding Author: Piman Limpaphayom, Sasin Graduate Institute of Business Administration, Chulalongkorn University, Chula 12, Phyathai Road, Bangkok 10330, Thailand. Telephone: 66(2) 2184028. E-mail: piman@sasin.chula. ac.th. ____________________________________________________________________________ The authors thank Anant Chiarawongse, J. Thomas Connelly, Kenneth A. Kim, Arnat Leemakdej, Nandu Nagarajan, and Patarapong Vongsvivut for valuable comments on earlier drafts of this paper. Financial support from Sasin Graduate Institute of Business Administration of Chulalongkorn University and the Master in Finance Program at Thammasat University is gratefully acknowledged. Managerial Ownership and Informativeness of Earnings: Evidence from Thailand Abstract This paper examines the relation between managerial ownership and the quality of accounting information in an emerging market. It is hypothesized that the relation between managerial ownership and earnings’ explanatory power of returns is negative and different from that documented in developed markets due to a unique institutional setting, leading to relatively high agency conflicts and information asymmetry. However, the relation between managerial ownership and earning informativeness becomes positive under financial distress because of the hypothesized effects of creditor monitoring, minority interest, and management’s desire to reduce further intervention. In addition, managerial ownership is positively related to the use of discretionary accruals. The finding is consistent with the notion that ownership structure affects the qua lity of accounting information.This paper examines the relation between managerial ownership and the quality of accounting information in an emerging market. It is hypothesized that the relation between managerial ownership and earnings’ explanatory power of returns is negative and different from that documented in developed markets due to a unique institutional setting, leading to relatively high agency conflicts and information asymmetry. However, the relation between managerial ownership and earning informativeness becomes positive under financial distress because of the hypothesized effects of creditor monitoring, minority interest, and management’s desire to reduce further intervention. In addition, managerial ownership is positively related to the use of discretionary accruals. The finding is consistent with the notion that ownership structure affects the qua lity of accounting information. Managerial Ownership and Informativeness of Earnings: Evidence from Thailand The Bank of Thailand’s release of the Baht peg and the subsequent devaluation of the Thai Baht on July 2, 1997, was viewed as the onset of the Asian financial crisis, which spreaded through the region. In Thailand, the crisis heralded the closing of financial institutions and resulted in an increase in the number of high non-performing loans and debt restructurings. Under this financial crisis, creditors and outside investors became increasingly concern about default risk and the credibility of information reported in a firm’s valuation. This resulted in several questions concerning the quality of information that a firm provides to outsiders, as updates to the projection of a firm’s performance use a wide variety of information sources. La Porta, Lopez-de-Silanes and Shileifer (1999) posit that, in most East Asian countries, corporate control is enhanced through pyramidal structures and cross-holdings among mainly family-controlled firms. Many researchers have attempted to explain the relationship between corporate ownership and earnings report quality, as corporate ownership structure in East Asian countries is unique in comparison to that in the United States. Fan and Wong (2002) examines the relations between earnings informativeness, measured by the earnings-return relation, and the ownership structure of 977 companies in seven East Asian economies. The results are consistent with two complementary explanations in which concentrated ownership and the associated pyramidal and cross-holding structures create agency conflicts between controlling owners and outside investors. Consequently, it is perceived that controlling owners report accounting information out of selfinterest, resulting in reported earnings with little credibility with outside investors. Furthermore, concentrated 1 “Quality” is defined as the usefulness of the financial statements in contracting, monitoring, and valuing and other decision-making activities by investors, creditors, managers and other parties contracting with the firm. (Ball & Shivakumar 2001) ownership structure is associated with low earnings report quality as ownership concentration prevents leakage of proprietary information about the firms’ rent-seeking activities. Warfield, Wild and Wild (1995) finds managerial ownership to be directly related with earnings report informativeness for returns and inversely related with the magnitude of accounting accrual adjustment. A study by Yeo, Tan, Ho and Chen (2002) on companies in Singapore consisting of 490 firm-year observations shows that earnings’ quality does not always increase with managerial ownership. At low levels of management ownership, earnings informativeness (the level of discretionary accruals) has positive (negative) relationship with management ownership. However, at higher levels of managerial ownership, this relationship reverses. This suggests the entrenchment effect to have possibly set in. Thailand provides a unique setting to test the relation between managerial ownership and earning informativeness. First of all, the corporate governance structure in Thailand is relatively weak compared with other developed economies. Low transparency and the lack of disclosure are two major problems in the Thai market (Zhuang, Edwards, Webb, and Capulong, 2000). Previous studies in East Asia have found that corporate governance affects firm valuation (Mitton, 2002; Lins, 2003). Consequent ly, the relation between managerial ownership and earnings informativeness in Thailand could be different from that observed in other developed markets. With the economic crisis in Thailand, further, many listed companies in the Stock Exchange of Thailand (SET) were either in the debt restructuring process or bankruptcy court due to an inability to pay back the principle and interest on loans outstanding. Thus creditors monitored closely the companies that were candidates for debt restructuring, leaving open the possibility for further intervention into the affairs of a financially distressed company that had reached agreement upon its debt restructuring process. Financial distress and the intervention of creditors raise questions concerning the relations among the levels of managerial ownership, the use of earnings management, and the informativeness of financial information after the crisis period. Lemmons and Lins (2003) find that the Asian crisis increases the incentives of controlling shareholders to expropriate wealth from minority shareholders. Consequently, the results from Thailand should provide insights on the relation among variables. This paper investigates how the separation of ownership and control affects the informativeness of accounting earnings in an emerging market with a unique institutional setting. Separating equity ownership from the control of corporate decisions is fundamental to contemporary firm theory (Jensen and Meckling, 1976; Fama, 1980; Fama and Jensen, 1983) in explaining principal-agent conflict of interest. It is predicted that, when managers hold less equity in the corporation, incentives arise for managers to pursue non-value-maximizing behaviors such as shirking and perquisite taking. Accordingly, contracts are written to restrict managers’ value-reducing behavior when ownership and control are distinct. This theory on the separation of ownership and control is utilized to formulate the hypothesis predicting how the informativeness of accounting earnings in explaining stock returns varies systematically with the level of managerial ownership in the corporation. This paper makes several contributions. First, several recent accounting studies (Ball, Kothari, and Robin, 2000) have provided evidence that, in addition to accounting standards, features of the institutional environment such as corporate governance as well as legal and financial systems can also explain the differences in the properties of accounting information across countries. Further, the paper extends the work by examining managerial ownership of financially distressed and non-financially distressed firms as a channel that influences reporting quality. This research should have implications for economic reformers and regulators who are striving to improve corporate governance and transparency in emerging economies. In general, the results suggest that managerial ownership affects the properties of accounting information. This paper is organized as follows: Section I presents the literature review of managerial ownership,