Unconsolidated separate financial statements and dividends: Evidence from Korea

Abstract

The purpose of this study is to investigate whether Korean parent firms manage dividend payments by taking advantage of the Commercial Act of Korea and accounting discretion allowed under the Korean IFRS. While IFRS adoption has transformed primary financial statements from unconsolidated to consolidated financial statements, the Commercial Act of Korea continues to compute distributable profits based on unconsolidated separate financial statements. The discrepancy between the earnings for financial reporting and the distributable profits provides an opportunity for a parent firm to manage dividends upward through internal transactions without affecting consolidated earnings. Using the parent firms listed on the Korea Exchange (KRX) during the period from 2001 to 2018, we examine whether these parent firms engage in dividend management through internal transactions to meet the dividend expectations of their shareholders in the post-IFRS period. We find that the parent firms with small consolidated but large unconsolidated earnings (‘SCLU’ firms) pay more dividends than others in the post-IFRS period when they have significant transactions with related parties. The dividend-increasing behavior of the SCLU firms through related-party transactions is more pronounced when the ownership of foreign shareholders or the largest shareholder is high. Our results suggest that Korean firms may pay excessive dividends by managing distributable profits despite poor consolidated performance in order to meet shareholders’ dividend demands.