The Effect of Corporate Governance on Earnings Quality and Market Reaction to Low Quality Earnings: Korean Evidence

Hyejeong Shin and Su-In Kim
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Hyejeong Shin: Department of Business Administration, Kyonggi University, 154-42 Gwanggyosan-ro, Yeongtong-gu, Suwon 16227, Korea
Su-In Kim: College of Business Management, Hongik University, 2639 Sejong-ro, Jochiwon-eup, Sejong-si 30016, Korea

Sustainability, 2018, vol. 11, issue 1, 1-17

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.

Keywords: board of directors; foreign investors; earnings quality; market reaction (search for similar items in EconPapers)
JEL-codes: O13 Q Q0 Q2 Q3 Q5 Q56 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:gam:jsusta:v:11:y:2018:i:1:p:102-:d:193053

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