Abstract
This study investigates whether corporate governance mechanisms are associated with earnings quality, especially accurate earnings reporting, and whether investors react differently to inaccurate earnings according to governance strength. Earnings accuracy is one of the key factors affecting a firm’s sustainability in the sense that reported earnings provide information about a firm’s long-term sustainability and further are directly associated with a firm’s cost of capital. In this paper, we employ the independence of the board of directors (BOD) and foreign ownership as governance mechanisms associated with the earnings gap between audited and unaudited earnings. Using 1976 non-financial firm-year observations listed on the Korea Stock Exchange from 2013 to 2016, we find that the gap between unaudited earnings and actual earnings is smaller for firms with independent BODs and foreign ownership, suggesting that earnings accuracy is higher for firms with effective corporate governance. This study also examines how investors react to the earnings gap. Stock returns to the earnings gap are less negative for firms with independent BODs and are more negative as foreign ownership increases, implying that each mechanism of corporate governance has different effects.
Highlights
This study examines the impact of corporate governance on earnings quality and investors’ reactions to low-quality earnings
This study investigates whether board independence and foreign ownership are associated with the disclosure of high earnings quality and whether market reactions to corrected earnings differ according to board independence and foreign ownership
Using the amendment of Korea’s External Audit Act in 2014, this paper finds that increases in the earnings gaps between unaudited earnings and actual earnings after the amendment are smaller for firms with independent board of directors (BOD) and higher foreign investor ownership
Summary
This study examines the impact of corporate governance on earnings quality and investors’ reactions to low-quality earnings. By assessing the earnings gap between unaudited earnings and audited earnings before and after the External Audit Act amendment, this study finds that firms in which an independent board and sophisticated investors monitor management’s behavior are more likely to report accurate earnings, supporting that effective corporate governance can improve firms’ ability to produce high-quality earnings. Foreign investors’ severe punishment of firms due to erroneous earnings in the post-amendment period implies that indicating higher earnings quality is important for retaining foreign investment in emerging markets Second, more importantly, this is different from prior studies on the monitoring effect of foreign investors in that we focus on an emerging issue of investor ‘exit’ threat.
Sign-in/Register to view highlights & summary Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
