Journal of Business Ethics

, Volume 103, Issue 3, pp 403–427 | Cite as

Business Ethics and Financial Reporting Quality: Evidence from Korea

Article

Abstract

This study examines the relationship between corporate commitment to business ethics and financial reporting quality. We posit that companies with a higher level of ethical commitment exhibit better quality financial reporting than those with a lower level of ethical commitment. Consistent with our prediction, we find that companies with a higher level of ethical commitment are engaged in less earnings management, report earnings more conservatively, and predict future cash flows more accurately than those with a lower level of ethical commitment. We also find that corporate commitment to business ethics has perpetuating effects on future financial reporting quality.

Keywords

business ethics financial reporting quality accruals conservatism corporate governance 

ABBREVIATIONS

ΔREV

Change in revenue

AvgA

Average total assets during the year

BE

Businesss ethics

B_Score

Timeliness of earnings with respect to bad news

C_Score

Asymmetric timeliness of earnings between bad and good news

CFO

Cash flow from operating activities

CGD

Indicator variable equal to one for companies with strong corporate governance

CONSV

Level of accounting conservatism

DA

Discretionary (unexpected) accruals

DR

Indicator variable that equals one when annual stock returns are negative

E

Net income scaled by the lagged market value of equity

ECI

Ethical Commitment Index

EntExpD

Indicator variable equal to one for companies with entertainment expenses deflated by sales greater than the sample median

FREP

Faithful representation

FREP_DA

Negative of the discretionary accruals from the Jones model

FREP_DAROAL

Negative of the discretionary accruals from the Jones model with lagged ROA

FringeBD

Indicator variable equal to one for companies with employee fringe benefits deflated by sales greater than the sample median

FRQ

Financial reporting quality

G_Score

Average timeliness of earnings with respect to good news

KOSDAQ

Korean Securities Dealers Automated Quotations

KRW

Korean Won

KSIC

Korean Standard Industry Classification

LEV

Leverage measured by the ratio of the sum of long-term and short-term debts to the market value of equity

LEVERAGE

Ratio of total liabilities to total assets

LossD

Indicator variable equal to one for companies that report losses

MTB

Market-to-book ratio

MTBD

Indicator variable equal to one for companies with market-to-book ratio less than unity

MV

Market value of equity

NegCFOD

Indicator variable equal to one for companies that report negative operating cash flows

NPV

Net Present Value

Pit–1

Lagged market value of equity

PPE

Property, plant, and equipment

QA

Quality (accuracy) of accruals

R

Annual stock returns for the 12-month period ending 3 months after the fiscal-period end

ROA

Return on assets

SizeMVE

Natural logarithm of the market value of equity

TA

Total accruals

Tobin’s Q

Ratio of the sum of total liabilities and the market value of equity divided by total assets

WC

Working capital accruals (current accruals) from the statement of cash flows

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Copyright information

© Springer Science+Business Media B.V. 2011

Authors and Affiliations

  1. 1.KDI School of Public Policy and ManagementSeoulKorea
  2. 2.Korea University Business SchoolSeoulKorea

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