The effect of corporate governance on earnings quality: evidence from Korea's corporate governance reform
Creators: name: An, Y
Publisher: name: RMIT University
Year: 2024

description: This thesis investigates the effect of corporate governance on earnings quality, following changes in corporate governance mechanisms in Korea, launched after the Asian Financial Crisis in 1997. It was motivated by two distinctive features of Korea’s corporate governance reforms: 1) non voluntary reform (enforced by the IMF and the World Bank) and 2) partial transplanting of a common-law regime.<br><br>The analysis utilizes panel data of 509 non-financial Korean firms and a total of 3,054 firm-year observations, listed on the Korean Stock Exchanges (KSE) for the period 2000-2005. This thesis employed three corporate governance mechanisms based on the Korea’s corporate governance reforms: 1) Ownership structure (family ownership and foreign ownership), 2) Internal governance (outside directors on the board and audit committee), and 3) External governance (external auditor). Following Jonas and Blanchet (2000), this study classifies earnings quality, as a proxy of financial reporting quality, into two types of approaches for assessing financial reporting quality: user needs and shareholder/investor protection. From the standpoint of user needs, earnings quality is associated with the relevance of the financial information and measured as earnings persistence and value-relevance, while earnings quality in the view of shareholder/investor protection is related to reliability of financial information and measured as conservatism and accruals quality.<br><br>With regard to ownership structure, this thesis finds that: (1) family ownership positively affects earnings quality on shareholder/investor protection (accruals quality); (2) pure family ownership positively affects both earnings quality associated with user needs (persistence) and shareholder/investor protection (accruals quality), and affiliated ownership shows mixed results; and (3) foreign ownership also increases earnings quality on user needs (persistence and value relevance).<br><br>As for the internal governance function, outside directors on boards partially increase earnings quality. Outside directors are related to earnings quality on user needs (value-relevance) but decrease earnings quality on shareholder/investor protection (accruals quality). Earnings quality depends on the background (quality) of outside directors on the board. There are negative associations between earnings quality and outside directors having high-profile backgrounds (e.g., politicians, government officers, and lawyers) and outside directors who are professors and foreigners, whereas outside directors who are finance experts and former employees are positively associated to earnings quality. Audit committee does not increase both earnings quality on user needs and on shareholder/investor protection. This result shows earnings quality appears determined by the intention of financial statements preparers and less so by regulations or institutions.<br><br>In terms of the external governance function, higher audit quality (Big N firms) positively affects earnings quality on shareholder/investor protection (conservatism and accruals quality). As a ‘public watch dog’ function of the capital markets, higher audit quality mitigates aggressive and opportunistic financial reporting, and thus plays a vital role in the external corporate governance. <br><br>This thesis contributes to the existing corporate governance and earnings quality literature in emerging markets by testing three key elements of corporate governance and four measures of earnings quality. The comprehensive investigation provides additional insights into the role of corporate governance in improving earnings quality as a proxy for financial reporting quality<br>