Has The Informativeness Of Accounting Numbers Improved After Accounting Regulations In Korea?

Abstract

This paper aims to examine whether the level of Earnings Management (EM) and informativeness of accounting information change after the enforcement of Internal Accounting Control System (IACS) Standards established by the Korea Listed Firms Association, introduced as one of the Accounting Reforms. We test the effectiveness of IACS standards using samples of listed large firms that were required to adopt IACS Standards from 2006 and of listed small and medium firms that did not have to adopt IACS Standards to implement IACS as non-adopters. We use absolute values of discretionary accruals as proxies for EM estimated by three models: (1) the Modified Jones model, (2) the Performance Matched model, and (3) the Forward Looking model. We test the hypothesis that there are changes in the level of earnings management before and after the enforcement of IACS Standards for adopters using multivariate regression models. We also test the change in the informativeness of accounting information before and after the enforcement of IACS Standards using earnings response coefficients (ERC) between earnings and returns for both samples. It was found that the level of EM is significantly reduced and the level of informativeness is improved after the enforcement of IACS Standards for adopters, while the levels of EM and informativeness are not significantly changed for not-adopters. Other control variables, such as cash flows from operations, size, debt ratio, and trends variables also turned out to be significant in explaining EM. The results imply that the reliability and the transparency of Korean firms' financial statements were improved by the enforcement of IACS Standards as they reduce earnings management. Also the informativeness of accounting numbers was increased after the enforcement of IACS Standards. This paper provides initial empirical evidence on the effectiveness of IACS Standards enforced in 2006.