Earnings quality of Taiwanese group firms

Abstract

This study examines the relationship between group firms and earnings quality. For the period 2000–2010, we examine the earnings quality of Taiwanese group and non-group firms through accrual persistence, earnings management, and conservatism. We show that group firms exhibit a lower quality of accrual persistence, have greater propensity to manage earnings, and are less conservative relative to non-group firms. Furthermore, we confirm the possible effects of group vertical relatedness and deviation of control rights from voting rights on earnings quality. These findings support the information asymmetry hypothesis that controlling shareholders have greater room to manage earnings in group firms.

Keywords:

• earnings quality
• group firms
• earnings management
• information asymmetry hypothesis

JEL Classification Codes:

• M41
• M42
• M48

Notes

1. Various proxies of earnings quality can be found in the accounting literature. Reviewing over 300 studies of characteristics or attributes of earnings, Dechow, Ge, and Schrand (2010) find no single conclusion to define earnings quality, because “quality” is contingent on the decision context.

2. According to the TEJ Corporate Governance – Group Information Database, a firm is considered as a group’s parent firm if it is at the top of a pyramidal shareholding, while remaining firms that form the group are known as member firms. In other words, the definition is based on the concept of ultimate controlling shareholders. Specifically, group firms include any of the following conditions: (1) major shareholders of the firms are made up of the same person or the same family members (the major shareholders refer to the top 10 shareholders or shareholders who hold more than 5% shareholdings); (2) at least one-third of directors and supervisors on the board are identical among the firms; (3) the firms have the same main business sectors and the CEO (or Chairman) of a member firm is also the CEO (or Chairman) of its core firm; (4) there exists a relationship of control or affiliation; and (5) there exists a relationship of mutual investment and the amount of investment exceeds one-third of the voting shares or total shareholders’ equities.

3. For group firms, some of the annual reports of member firms are not consolidated in the group’s annual reports, providing limited support to the offsetting accruals hypothesis. Unlike group firms, the financial statements of an affiliated firm are consolidated if a controlling firm has more than 50% ownership in that affiliated firm. See footnote 2 on page 5 for detailed discussions on the definition of groups firms. Note that this paper attempts to document the earnings quality of group firms empirically.

4. Note that discretionary accrual models are commonly used in the earnings management literature (Hansen 2002).

5. The IO tables are official statistics published by statistical bureau and can be accessed from the website: http://www.stat.gov.tw/ct.asp?xItem=28535&ctNode=671&mp=4.

6. We employ “10% of sales revenue” as a cut-off point to define a primary product in individual firms. of each member from its financial statement disclosures and trace every primary product to its corresponding industrial sector.

7. Taiwan Directorate-General of Budget, Accounting and Statistics defines roughly 166 industrial sectors. We employ relevant detail and public data to capture the relatedness of products.