Global Diversification, Real Earnings Management, and Future Performance: Evidence from Korea

ABSTRACT

Research has generally focused on demonstrating real earnings management (REM) stemming from managerial opportunism using the agency framework. Examining a sample of firms on the Korea Composite Stock Price Index from 2011 to 2019, we explore the benefits of REM. Empirical results show a positive relationship between corporate globalization and the extent of REM, and corporate globalization mitigates the negative relationship between REM and future (operating and market) performance, observed only in firms with a low incentive to engage in REM for zero earnings. Global firms with more operational flexibility may strategically utilize REM to avoid temporary crises and perform better in the future.

KEYWORDS:

• Global diversification
• real earnings management
• signaling
• information asymmetry
• future performance

JEL:

• G30
• L25
• M41

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1. Cohen, Pandit, and Wasley (2019) raise the concern that the traditional REM model provided by Roychowdhury (2006) exhibits low explanatory power because they oversimplify the underlying economics of the relation. In other words, expected real activity levels could differ across firms, even in the same industry. As a simple way to consider these potential nonlinearities and omitted variables, Cohen, Pandit, and Wasley (2019) propose the performance-matching approach to estimating the normal level of real activities.

2. We perform the analysis for Hypothesis 1 based on the sample period from 2011 to 2016 (n = 2,793) and find qualitatively similar results as Table 3. For the sake of brevity, the table is not presented.

3. Channel stuffing refers to the practice of a company shipping more goods to distributors and retailers along the distribution channel than end-users are likely to buy in a reasonable time. This is usually achieved by offering lucrative incentives, including deep discounts, rebates, and extended payment terms, to persuade distributors and retailers to buy quantities exceeding their current needs.

4. For brevity, we only present the results with the PA_SUM as an independent variable as we found qualitatively similar results and inferences with the other three individual REM measures.