Separation of corporate ownership and control and accounting conservatism: evidence from Korea

Myung-In Kim, Catherine Heyjung Sonu* & Jong-Hag Choi

Abstract
This study analyzes how the separation of corporate ownership and control affects financial reporting conservatism using unique data on Korean chaebol-affiliated firms. The presence of severe agency problems generated by the wedge between ownership and control may increase the demand for conservatism, while the greater managerial motivation and latitude in making accounting choices borne by the entrenchment problems can adversely affect the degree of financial reporting conservatism. We find that the ownership-control wedge is negatively associated with various proxies for conservatism, consistent with the entrenchment argument. Additional analyses reveal that a wide divergence between ownership and control adversely affects the corporate governance of a firm. Further, we find that the negative effects of the ownership-control wedge on conservatism are particularly strong for firms with weak corporate governance. Overall, we provide evidence that controlling shareholders act as a mechanism to mitigate the role of corporate governance, thus reducing implementation of conservatism.

Keywords: ownership structure, excess control rights, corporate governance, conservatism
JEL codes: , G34, M40, M41

Audit duration quality and client credit risk

Pei-Gi Shu, Tsung-Kang Chen and Wen-Jye Hung*
Fu Jen Catholic University, Taiwan

Abstract
Using Taiwanese listed firms, we examined how auditor-related idiosyncratic risk affects clients’ credit risks from the perspective of audit duration quality, including the level and volatility of audit report lag (ARL). We find that both the level and the volatility of ARL are positively related to clients’ credit risks when other well-known determinant variables are controlled. In addition, the level (volatility) of ARL has weaker (greater) power in predicting the financial crisis of client firms associated with the Big-4 auditing firms than the non-Big-4 ones. Moreover, the results are robust to the issue that ARL may be long, the concern of initially engaged clients, different estimation periods of ARL volatility, and another credit risk measure.

Keywords: audit duration quality, audit report lag (ARL), audit report lag volatility, credit risk, financial distress
JEL codes: M42, G33

Long-term growth forecasts and stock recommendation profitability

Andreas Simon*, Pepperdine University, USA
John Nowland, City University of Hong Kong, Hong Kong

Abstract
We investigate whether analysts’ long-term growth (LTG) forecasts are a signal of analyst effort to better understand the future prospects of firms, which is reflected in the long-term profitability of their stock recommendations. We develop a one-year-ahead LTG forecast likelihood score and execute a trading strategy that generates average abnormal returns of 2.9% per annum over our sample period (1995–2005). Furthermore, in out-of-sample testing without portfolio rebalancing during the 2006–2011 period, our trading strategy earns abnormal returns of 2.5% per annum. In summary, this study illustrates previously undocumented long-term benefits accruing to investors from the information inherent in analyst LTG forecasts.

Keywords: analyst forecasts, long-term earnings growth, stock recommendations, trading strategy
JEL Codes: G11, G14

Are evaluations of audit quality influenced by management’s intentions and outcomes?

Karim Jamal, University of Alberta, Canada
Hanwen Chen, Xiamen University, China
Le Luo*, Peking University, China

Abstract
One major regulatory device for improving audit quality is to require auditors to assess the ‘Tone at the Top’ (that is, the integrity and especially top management’s intentions and attitude towards earnings management), but prior audit research suggests that auditors are quite poor at assessing the knowledge, preferences and intentions of others. In this study, we report results of two experiments in which a material misstatement occurs intentionally (fraud) or inadvertently (error). Shareholders suffer a loss (or no adverse consequence). Experienced auditors (Certified Public Accountants [CPAs]) and a control group of university students assess the appropriateness of the auditor’s conduct and specify a penalty. Experiment 1 results show that CPAs are not influenced by management’s intentions or outcomes. Students are responsive to outcomes but not to management’s intentions. In Experiment 2, we re-ran Experiment 1 using a within-subjects design to make management’s intentions more salient. Experiment 2 results indicate that, this time, both CPAs and students respond to intention but in a manner opposite of that prescribed by professional standards. Students also respond to outcomes, though CPAs do not.

Soccer sentiment and investment opportunities in the Korean stock market

In Kang & Cheolbeom Park*, Korea University, Korea

Abstract
We have found a significant sentiment effect from national soccer match outcomes on the Korean stock market, consistent with studies on other countries. Further investigation reveals, however, that such sentiment effect is extremely short-lived and the magnitude of ensuing expected returns based on the sentiment effect is about the same as the transaction costs. Therefore, we conclude that although a significant soccer-sentiment effect from losses exists, it seems almost impossible to devise reliable arbitrage opportunities from it due to its short duration and the small magnitude of expected returns.

Keywords: sentiment effect, soccer, stock returns, transaction costs
JEL codes: G02, G11, G12