■ 国際会計研究学会 年報 2014 年度 第 1 号

Relation between Corporate Governance andEarnings Mangement, and the Role of IFRS:Evidence from Korea*
Hyuk Shawn
Keimyung University

Jae-gyung Jung
Tongmyong University

Sang-ho Do
Keimyung University

Abstract
Korea has adopted International Financial Reporting Standards(IFRS) since 2011 to mitigate information asymmetry between
internal and external users by delivering sufficient and informative
disclosure. However, IFRS may be an alternative purpose formanagers to maximize their utilities by using discretions. This study
examines whether discretionary accruals (DA) or real earnings
management (RM) are influenced by the adoption of International
Financial

ReportingStandards(IFRS)

in

Korea,

andthen

investigates whether the role of corporate governance to constrain DA
or RM is different. Also, we investigate whether DA was replaced by
RM after the mandatory adoption of K-IFRS since 2011. Recent
studies show that it is difficult for managers to use DA whenregulations strengthen. Our results find that the intensity of RM
increases after IFRS era, suggesting IFRS do a role as regulation
because information users, auditors as well as regulators havedifficulties to detect RM. Meanwhile, the extent of DA or RM issmaller in firms with good corporate governance after the adoption of
IFRS. These results imply that the magnitude of RM can be increased
by giving discretion to manager in IFRS era and that corporate
governance still plays an important role as a determinant of earnings
management.

139

Key words: IFRS, Corporate governance, Discretionary accruals, Real earnings management.
JEL classification: M41*This research was supported by Jungmoo scholarship association.
level of the OECD although Korea has

1. Introduction
Corporate

introduced

governancereform bills since 2003 affected by thedecision-making processes and structures toSarbanes-Oxley Act of 2002. This is resulted

monitororfrom various factors, but the inefficiency of

executives’ activities in order to attainthe Korean GAAP and corporate governancecompany’s goals (La Porta et al. 2000).

can be a decisive factor. Therefore, Korea has

Problems associated with the corporate

adopted International Financial Reporting

governance are caused by the trade-offs

Standards (hereinafter IFRS) since 2011 to

between shareholders and managers or

mitigate intransparency of capital market. It

amongcloselymeans that the adoption of IFRS is expectedconnected with agency costs. Regarding

to not only enhance quantity or quality ofcorporate governance, there have been many

disclosure but increase reliability of financial

studies on the correlations between specificinformation.

shareholding rate or management ownershipprinciple-based accounting can also give

rate and enterprise value or earnings

discretion to firm’s managers so that they

management. In Korea, there have beencanexisted various problems of the corporate

information reflecting their substance of thegovernance related with the peculiar type ofcompanies compared to the previous Koreanchaebol,

GAAP (hereinafter,

controlshareholders,circularaacompany’s

whichequityseriesaccounting

of

and

is

various corporateisinvestment

IFRS

present

basedmarketontheparticipants

K-GAAP).

In

with

other

structure, etc.; there is a view on that thesewords, IFRS enable companies to give a

problems brought about the financial crisis

chance to reduce information asymmetry

in 1997(Johnson et al. 2000). Corporate

between internal and external users bygovernance problems in Korea have beendeliveringremoved a lot since the financial crisis, yetdisclosure. However, there may be an

the efficiency of Korean companies is notalternative

high, compared to that of North American or

maximize their utilities by using discretions

European ones.

granted in K-IFRS (Francis and Wang 2008;

This fact can be confirmed through theaccounting transparency index, which is

purposeandfor

informative
managers

toBall 2009).
The difference of the corporate governanceaffected by corporate governance; the Koreansignificantly

index remains the lowest position in the

management

140

sufficient

influencesof

executives.

earnings
It

can

be

Relation between Corporate Governance and Earnings Management, and the Role of IFRS

interpretedasagencycosts

betweendeveloping or East Asian countries including

shareholders and managers if the earnings

Korea, separation of ownership and control

management intended by managers lowers

is not well established, thereby emphasizing

firm values. However, there also exist

the importance of agency costs between

contrary opinions. After Berle and Means

controlling and minority shareholders.

(1932) first mentioned the separation ofTheories on corporate governance areownership and control, the agency costs

classified into two: the expropriation oftheory by Jensen and Meckling (1976)

minority shareholder hypothesis and the

explained that if controlling shareholders’convergenceshareholding rate increases, firm values

According to the former hypothesis, if theshould be higher through lowered agency

shareholding rate of controlling shareholders

costs between equity holders and managers.

is increasing, a motivation will exist for

While according to recent studies, agency

managers to report their income higher thancosts are involved by not only between

the actual figures; the latter estimates thatowners and managers but also between

highershareholders, i.e. controlling shareholders

shareholders

and minority ones; higher shareholding ratereporting their income lower than the real.

of major shareholders increases agency costs

Prior researches have focused on verifying

betweenwhich

controllingshareholders

andminority ones, which negatively affects
enterprise values.

ofinterest

shareholding

rate

seduces

hypotheses

hypothesis.

ofcontrolling

managers

intocorresponds

withcharacteristics of Korea.
Managers have different incentives withIn the cases of Korea, one of the maintypes of corporate governance. Existingcauses of the financial crisis is vulnerability

studies have described that managers areof the corporate governance that impedes to

not active subjects but passive ones who aremonitorwhich

apt to be affected by controlling shareholders

corresponds with the theories of La Porta etand have tendency to report their income toal. (1998, 1999 and 2000). According to La

satisfy specific aims. However, it cannot

Porta et al., where legal protection for theconclude that managers have incentives tominority shareholders remains weak, there

report their income higher or lower than theareactualmoremanagers’possibilities

activities,ofopportunistic

depending

on

the

level

of

of

controlling

activities of controlling shareholders andshareholding

incentives to infringe on minority’s interests.

shareholders. Instead, managers do have

In companies of North America or European

incentives to adjust their incomes according

countries, where ownership and control

to managers’ own shareholding rate or

separate comparatively well, the importancecompensation system. Hence this study

of

and

examines how each case affects earningsofmanagement, classifying cases into two:

agencymanagers

costs
isbetweenemphasized;

owners
in

firms

rates

141

owner-manager and employed-manager, andperiod. Also, we investigate whether DM was

focusing on the shareholding rate of the chief

replaced by RM under minority shareholder

executive

(CEO)

not

that

of

ratio after

controllingshareholders.

It

will

be

K-IFRS since 2011. Recent studies show thatreasonablethat

owner-managers

areit is difficult to use DM for the earnings

inclined to adjust their incomes not tomanagement when regulations such as

infringement shareholders’ interests because

Sarbanes-Oxley

managers are shareholders at the same time;2008). It means that managers can use RM

employed-managers tend to adjust theirmore frequently because information users,

incomes to maximize their interests evenauditorsthough these activities violate shareholders’difficulties to detect RM if K-IFRS do a roleinterest. Existing studies have tendency toas regulation.

officer

substitute shareholding rate of managers forthe mandatory adoption of

as

Act

well

strengthenas(Cohenregulators

have

By inspecting directions and types ofthat of controlling shareholders including

earnings

the most dominant shareholder and theprovide more information than existing

specially-interested; in the present situation

studies and helps overcome the present

where people can obtain data on whether thesituation

CEO is a controlling shareholder or not, it

inefficient. Various established studies havecan be better to examine the relationshipalso presented irrelative results between

between earnings management and the data

corporate governance and DM or conflictratherresults according to empirical results; this

than

using

the

proxy

index,

management,

that

this

corporate

study

governance

will

is

study is expected to help better understandcontrolling shareholding rate.
have

and interpret directions and types of eachearnings

earning management depending on adoption

management through discretionary accruals.

of K-IFRS. Also, we show the existence of

However, earnings management comes fromtrade-offs

betweenshareholders

andreal-activity earnings management (RM) as

managersorshareholders

and

well

implies the possible existence of the optimal

Meanwhile,
examinedastheexisting
degreediscretionary

studiesofaccruals

(DM).

among

Therefore, it can be taken into accountcorporate

governancewhich

minimizes

whether manager can use either accruals

agency costs depending on situations.

(DM) or cash from operations (RM) in order
to confirm the effect of the system such as
corporate governance or adoption of IFRS.

2. Prior Studies and Hypotheses

Thus, we divide earnings management into

Studies on corporate governance andDM and RM and examine how each earning

characteristics of managers can usually be

management level would be changed duringclassified into two: Studies which represent

post-IFRS period compared to pre-IFRS

that agency costs between shareholders and142

Relation between Corporate Governance and Earnings Management, and the Role of IFRS

managers will increase in the case of

1997 and the higher degree of convergence ofseparatedshares ownership brings on violating moresharesownership,

i.e.,

the

influence of employed-managers; researchesinterests of minority shareholders.

which indicate that agency costs between

In Korea, Park (2003) examines thecontrolling shareholders and minority ones

correlation between shareholding rate of thewill be increasing in the case of converged

most dominant shareholder and earnings

shares ownership, i.e., the influence ofmanagement of managers; he empiricallyowner-managers. According to the agency

verifytheory by Jensen and Meckling (1976), if the

between the most dominant shareholder’s

degree of dispersion between ownership andshareholding

management is increasing, the agency costs

accruals, which means that in a company

will be also increasing since managers canwith higher shareholding rate of the mostpossess more discretionary powers to act;

dominant shareholder, its managers havecompanies with convergence of shareholding

more incentives to increase their income

areusing discretionary accruals.

able

to

monitorintensively

theirsignificant

positive

rate

and

correlation
discretionary

managers and then, the enterprise value will

The implementation of IFRS leads to an

be increasing. Morck et al. (1998)’s study

improvement in earnings quality (Barth etalso supported this idea that if ownershipal. 2008). Prior studies also recognize theand control are centralized, the values ofbenefits of IFRS adoption, including greater

shareholders will be increasing because ofcomparability,

declined conflicts among interested parties.

management, more effectiveness of corporate

While

recentstudiespresent

reducedearnings

thatgovernance (Ipino and Parbonetti 2011;

centralized ownership gives a negative effectMarra et al. 2011). Marra et al. (2011) also

on the wealth of minority shareholders.

confirm that IFRS adoption helps board

According to La Porta et al. (1998, 1999 andeffectiveness due to the higher level of2000), there exist the trade-offs between

disclosure and transparency inherent incontrolling shareholders and minority ones,

IFRS.

which are regarded as the agency costs

Vanstraelen (2005), Daske et al. (2011)

between shareholders. This opinion meanssuggest that financial quality of voluntarythat the convergence of shareholding rate

IFRS

obstructs the firm value, which is contrary toFurthermore, managers may use discretions

the study of Jensen and Meckling (1976).

granted in K-IFRS for maximizing their

The view of La Porta et al. applies well inutilities (Francis and Wang 2008; Ball 2009).

cases of East Asian countries including

Thus, prior studies investigating the effect of

Korea. Johnson et al. (2000) suggest that the

IFRS adoption give mixed evidence.

problems of corporate governance are a key
factor of the East Asian financial crisis in

However,

adopters

Meanwhile,

Van

is

there

Tandeloo

not

are

and

ameliorated.

recentlysomepapers that focus on the effect of IFRS on
143

earnings management. Callao and Jarne

diminishment of COGS through RM of(2010) examine whether the adoption ofcurrent period exert a negative influence on

IFRS in the European Union has intensified

future operating activities. Roychowdhury

discretionary accruals by comparing pre-(2006) developed a model of measuring RM

with post-IFRS era. Their results show thatwhich aims to increasing earnings throughdiscretionary accruals have increased sinceprice cutting, over-production of inventories

the adoption of IFRS, implying that IFRS

and reduction of discretionary expenditures.

can give discretion to the firms’ managers.

Mizik et al. (2008) insisted that theOn the other hand, Kim (2014) shows thatmarketthe adoption of IFRS in Korea decreases

company

discretionary accruals. These results suggest

management at the time of seasoned equity

that IFRS mitigate information asymmetryofferings.

between mangers and outsider by disclosing

management through RM aiming higher

increased footnotes.

income report is carried out more thanPrior studies that focus on the effect of
IFRS

on

earnings

not

that
It

is

properly

carries
becauseevaluate

out
the

a

earnings
earnings

through DM. According to Edelstein et al.

mostly(2008), American investment companies in

confirm discretionary accruals (hereafter

real estate have to pay out 90% of net income

DM). However, Field et al. (2001) conclude

for the current year by the federal law, andthat recently research made limited progress

he showed that these companies increased

inofexpense and reduced net income using RM toaccounting choice because of limitations in

reduce amounts of their obligatory dividend.

research design. That is, most of studies on

Coulton et al. (2008) confirmed that aearnings management are involved in DA,

manager use RM in the fourth quarterbutearnings

mainly to meet earnings objectives. And they

management (hereafter RM) that affects

added the type of earnings management can

cash

be altered according to the purpose of

expandingstudiesflows

management

does

our

on

understanding

real-activity

haveexistedpartially(Roychowdhury 2006).

financial reporting. Cohen and Zarowin

Mande et al. (2000) proved that managers
useofused at the time of seasoned equity offerings

discretionary controlling the expenditure forand these have significant negative (-)

research

expensescorrelation meaning these have a relation ofaccording to economic conditions. Gunny

contradiction. Zang (2012) confirmed that(2010) investigated four types of earnings

DM and RM can be used as substitutes for

management i.e. research and development

each other. And he confirmed that there isexpenses,administrative

the sequence between these two, i.e. using

expenses, gains on disposal of long-term

RM firstly, then DM secondly. And aassetscompany’s manager who has litigation risks

144

short-term
andmakingdevelopment

sellinganddecision(2010) showed that RM as well as DM isandinvestment

assets,andRelation between Corporate Governance and Earnings Management, and the Role of IFRS

switches using DM to depending on RM,

Hence choose managers the method withfrom this result, it can be asserted that there

their purpose when adjust their earnings.

exists the trade-off relationship between RM

Minority shareholders are not easy to accessand DM. This hints that RM is a type ofinternal information on the firms. Therefore,

earnings management that is hardly exposed

they prefer to expand the amount of firms’

than DM.

disclosure in order to reduce agency costs.

In the cases of the United States, there are

IFRS can reduce information gap between

various researches including Cohen et al.

managers and investors. This means that(2008),

thethe adoption of IFRS can mitigate earnings

introduction of the Sarbanes-Oxley Act ofmanagement using information asymmetry.

2002, also known as the Public Company

IFRS adoption also helps board effectivenessAccounting Reform and Investor Protection

due to the higher level of disclosure andAct of 2002, types of earnings managementtransparency inherent in IFRS (Marra et al.

has been changed. In other words, after the2011). That is, IFRS can provide investors

introduction of the SOX Act, earnings

more faithful information reduce agency

management has been transformed from DM

costs

to RM. Ipino and Parbonetti (2011) examine

information on fair values is provided

whether managers substitute DM for RM

through IFRS and increasing disclosure ofafter IFRS become mandatory. They find afootnotes

decreaseforcomparing to local GAAP (Gassen andmandatory IFRS adopters only in country

Sellhorn 2006; Christensen et al. 2008).

with strict enforcement regimes. These

Therefore, a firm

results imply that managers can replace RM

ownership is high tends to adopt IFRS earlyby DM when facing tighten accounting

in Korea (Shawn and Jung 2013). The

standards or strict enforce regimes, because

adoption of IFRS, on the other hand, can give

it is more difficult to detect RM (Ewert andan effect on strict accounting policy or

Wagenhofer 2005; Graham et al. 2005).

regimes to the firm whose dispersion ofwhich

support(increase)

in

that

DM

since

(RM)

among

shareholders,

includes

more

whose

becauseinformation

dispersionofManagers have incentives to adjust firms’

ownership is high. Therefore, the firms

earnings to maximize their private interests

having the high ratio of the minority

under the authority. Studies so far haveshareholders can use RM rather than DM.

recognized

To sum it up, we can set up a hypothesis asthatmanagers

adjusttheir

incomes under their discretionary power toact,therebyon

earnings

discretionary

accruals.

Hypothesis: Companies with high dispersion

However, methods to examine earningsof ownership will substitute DM for RM after

management can be divided into two:

IFRS become mandatory.

management

focusing

follows.

byearnings management by using DM or RM.
145

Our model expects, after the adoption of

3. Research Design

IFRS, if IFRS are strict accounting practices,

3.1 Multivariate Modelthat is, if the increasing of earnings quality

To identify hypothesis, we use regression

and

the

effectivenessofcorporate

analysis. Our regression model describes as

governance under IFRS era will be higher,

follow.

the regression coefficient of β1 is expected tohave positive (+) value; however, this results

EMit

=

β0 +

β1IFRSit+

may be changed by dependent variables, DM

β3IFRS*RMSit + β4SIZEit + β5LEVit + β6OCFit

or RM. In other to confirm how the+

distribution of ownership related corporate

β7GROWTHit ++β8RFSit +β2RMSitβ9BIG4it+

β10NEGEit + βk∑INDit + εit (1)governanceaffectseachearnings

management such as DM or RM after the

EMit: level of each earnings management for

introduction of IFRS, we include RMS, whichfirm i in year t, that is, each earnings

signifies a ratio of minority shareholder, thatmanagement means discretionary accruals

is, one minus the largest shareholder andor real-activity earnings management

related party ownership at the ending of

IFRSit: 1 if year is after 2011 and 0 otherwise

fiscalRMSit: ratio of minority shareholder for firmownership has a favorable effect on each

i in year t (= 1 minus ratio of the largest

earnings

shareholder

coefficient of β2 is expected to have negative

and

the

related

party

year.

If

the

decentralization

management,

the

of

regression

ownership)(-) value; under the diversified ownership,

SIZEit: natural logarithm of total assets forfirms decrease earnings management infirm i in year torder to mitigate information asymmetry

LEVit: total debt divided by total equity for

between majority shareholders and minority

firm i in year t

ones. Moreover, if minority shareholders

OCFit: Operating Cash Flow for firm i in year

demandtpractice after the adoption of IFRS, the

GROWTHit: growth rate of sales for firm i inregression coefficient of β3 is expected toyear thave significant negative (-) value.

RFSit: ratio of foreign shareholder for firm ihigherqualityofaccounting

Meanwhile, leverage of liabilities (LEV),in year t

asset size of a firm (SIZE) and the growthBIG4it: 1 if firm i's auditor is big4 and 0

rate of total assets (GROWTH), all of which

otherwise

are considered to influence the size of

NEGEit: 1 if firm i's net income is negative

earnings management, are also included inand 0 otherwise

this model as control variables (DeFond and

IND: industry dummy variable

Jiambalvo 1994; Watts and Zimmerman1986). If the growth rate of the firm

146

Relation between Corporate Governance and Earnings Management, and the Role of IFRS(GROWTH) is high, managers can report

the year of t-1; PPEit: gross property, planthigher returns for tax purposes. Operatingand equipment. Ai,t-1: total assets of the firm

Cash Flow (OCF) is used to control not only

i in the year of t-1. And; εit: the residual

firms’ size and their earnings management(Dechow et al. 1995). As auditor's size or

Total accruals (TA) are computed from net

reputation becomes higher (BIG4), earnings

income minus cash flows from operating

management will decrease because theactivities (OCF). And discretionary accruals

auditor will try to increase accounting

aretransparency

non-discretionarytoelevate

their

own

reputation. We include the ratio of foreign

calculatedbysubtracting

accruals

from

total

accruals.

shareholders (RFS) as control variables forearnings management (Bamber et al. 2010).
Finally, we consider loss firm (NEGE)
because loss firm may affect reporting way inorder to reduce the deficits (Bugstahler andDichev 1997; Bamber et al. 2010).

3.2.2 Real Activity Earnings
Management (DM)One of most favored proxies of real
activity-based income adjustments is themodel used by Roychowdhury (2006), whichis intended to capture the abnormality level

3.2 Proxies of Earnings Managementof cash flows from operating activities (OCF),

3.2.1 Accrual-based Earnings
Management (DM)production costs and discretionary expenses.

We use discretionary accruals (DM) as theincreased the validity of this method by

proxy

of

accrual-basedAndearnings

management. For the measurement of these

Zang(2012)

andGunny(2010)

verifying this proxy of Roychowdhury (2006)
empirically.

adjustments, we use the Adjusted Jones

The details of real activity-based income

Model (1995), frequently used in various

adjustments from those three variables inprevious studies. And, the Adjusted Jones

the above can be stated as follows:

Model is as follows:

1) OCF : A company can accelerate
point of sales by price discounts orTAit/Ai,t-1 =a0[1/Ai,t-1]+b1[(ΔREVit －ΔRECit)/Ai,t-1] + b2[PPEit/Ai,t-1] + εit (2)relief of credit conditions
2) Production costs: A company canlower the cost of sales by increasing

where i, t are firm and year, respectively.

TAit: total accruals; ΔREVit: the change of

production volumes.
3) Discretionary expenses: A company

Sales of the firm i in the year of t, as

cancompared from the year of t-1; ΔRECit: thedecreasing discretionary expenses

change of account receivables from trade ofincludingthe firm i in the year of t, as compared fromresearch & development expenses

reducecash

outflows

advertisingbyexpenses,

147

and

sellingandadministrative

When using equation (4) and equation (5),the normal costs of production can be derived

expenses.
Roychowdhury (2006) uses the method of

as follows:

the actual amounts minus the normal
amountswhich

exercising

real

are

considered

activity-based

as

not

incomeProdit/Ai,t-1 = a0[1/Ai,t-1] + b1[Salesit/Ai,t-1] +b2[ΔSalesit/Ai,t-1] + b3[ΔSalesi,t-1/Ai,t-1]+ εi (6)adjustments, to measure abnormal amountsof OCF, production costs and discretionary

The normal discretionary expenses are theexpenses. Meanwhile, the normal amounts ofsum of advertising expenses, research &OCF, production costs and discretionary

development expenses (R&D) and selling

expenses are computed from the method

and administrative expenses (SG&A). In thisdeveloped by Dechow, Kothari and Watts

paper, we consider the normal discretionary(1998) as it is. In the viewpoint of DKWexpenses in the current year have a linear(1998), the normal OCF is tacitly consideredrelationship with sales in the prior year as

to have a linear relationship with the sales

we adopt the method used by Cohen et al.

amounts and the change of sales amounts.

(2008). If we apply sales in the current year

And the details of equations are as follows:in the model, it will be difficult to capture thedecrease in the residual for a case that the

OCFit/Ai,t-1 = a0[1/Ai,t-1] + b1[Salesit/Ai,t-1] +managementb2[ΔSalesit/Ai,t-1] + εit (3)which is not actually occurred; we may haveexaggerates

sales

amountvery little residuals in that case, as a result,
The cost of production is defined as thesum of the cost of goods sold (COGS) and thesales in the prior year is used in the equation.
The details of the equation are as follows:change of inventories. We can derive thisbelow equation from equation (4), as it is

DisExpit/Ai,t-1 = a0[1/Ai,t-1] + b1[Salesi,t-1/Ai,t-1]

acceptable that the relationship between the+ εit (7)COGS and sales of certain year is almost
linear.

We can calculate the abnormal OCF, theabnormal production costs and the abnormal

COGSit/Ai,t-1 = a0[1/Ai,t-1] + b1[Salesit/Ai,t-1] +discretionary expenses. And, in using theseεit (4)three factors to output the proxy of the realearnings management, we calculate the

The change of inventories can be derived
as follows:

standardized variable by connecting all ofthese three factors to be denoted as RM.

ΔINVit/Ai,t-1 = a0[1/Ai,t-1] + b1[ΔSalesit/Ai,t-1] +3.3 Sample Selection

b2[ΔSalesi,t-1/Ai,t-1]+ εit (5)Korea has adopted IFRS since 2011. First,

148

Relation between Corporate Governance and Earnings Management, and the Role of IFRS

we divide sample periods into pre-IFRS(2008~2010) and post-IFRS (2011~2013). We
get financial information and stock prices of
the companies from KIS-VALUE of Korea
Information Service and TS-2000 of Korea
Listed Companies Association as follows.
(1) KOSPI- or KOSDAQ-listed companies
which settle their accounts in December(2) Manufacturing industry except financial
business and issues for administration(3) Companies whose financial data can getfrom KIS-VALUE of Korea Information
ServiceandTS-2000

of

Korea

ListedCompanies Association
To perform empirical studies, we analyzed
firms which met the above conditions from2008 to 2013. The number of the total
samples is 9,408.
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