Skip to main content
SpringerLink
Log in

The effect of controlling shareholders’ excess board seats control on financial restatements: evidence from Taiwan

  • Original paper
  • Published:
Review of Quantitative Finance and Accounting Aims and scope Submit manuscript

Abstract

This study examines the relation between controlling shareholders’ excess board seats control and financial restatements. An analysis of a sample comprising 106 Taiwanese listed firms (53 restating firms vs. 53 non-restating control firms) shows that financial restatements are more likely to occur when there is a greater divergence between controlling shareholders’ board seats control rights and ownership rights. We also find that the excess board seats control of controlling shareholders is positively associated with the materiality and pervasiveness of financial restatements. Overall, these results suggest that the entrenchment incentive from controlling shareholders’ excess control motivates firms to adopt aggressive accounting policies.

This is a preview of subscription content, log in via an institution to check access.

Access this article

Log in via an institution

Price excludes VAT (USA)
Tax calculation will be finalised during checkout.

Instant access to the full article PDF.

Institutional subscriptions

Similar content being viewed by others

Notes

  1. Similar to German boards, corporate boards in Taiwan are composed of two separate organizations—a board of directors and a board of supervisors. Directors are responsible for managing the firm while supervisors are responsible for monitoring the directors.

  2. According to Taiwan’s Company Law, at the end of each fiscal year, the board of directors is responsible for the preparation of financial statements, which are to be forwarded to the supervisors for their auditing no later than the 30th day prior to the meeting date of a general meeting of shareholders.

  3. This risk is also recognized by auditors, who consider a concentration of power in the hands of one person or a small group who act in concert as a red-flag indicator of a potential fraudulent situation (Loebbecke et al. 1989).

  4. Previous studies provide evidence supporting the positive incentive effect from ultimate owners’ cash-flow rights. For example, La Porta et al. (2002) examine 539 large firms from 27 wealthy economies and find that firms with higher cash-flow ownership by the controlling shareholder have higher valuation. Similarly, using data for 1,301 publicly traded corporations in eight East Asian economies, Claessens et al. (2002) find that firm value increases with the cash-flow ownership of the largest shareholder.

  5. This phenomenon can be attributed to the imperfections of related laws in Taiwan. First, Taiwan’s Corporate Law allows institutional shareholders to elect representatives to the board; therefore, controlling shareholders have the ability to increase their influence over the board by creating nominal investment companies that in turn become institutional shareholders in the firm. Second, even though Taiwan’s Corporate Law stipulates that no current employees or directors can serve as supervisors, it does not prohibit family members of current employees or directors from serving as supervisors. As a result, it is common to see family members of controlling shareholders serving as supervisors.

  6. Following Claessens et al. (2000) and Yeh et al. (2003), we use the 10% cutoff criterion, i.e., the control (voting) rights of the largest shareholder exceeding 10%, to identify controlling shareholders. We obtain similar results if we use 20% cutoff criterion to judge the controlling shareholder.

  7. T N Soong & Co and Deloitte & Touche Taiwan were combined to become Deloitte & Touche (D&T) on June 1, 2003. Thereafter, the original Big 5 audit firms became the Big 4 audit firms. We assign the value of Bigfirm using the “Big 5 criterion” before the combination and the “Big 4 criterion” after the combination.

  8. We also use the restated operating revenues as a deflator to check the robustness and the result is not affected significantly.

  9. Cameron and Windmeijer (1996) indicate that the preferred R2 measure for standard count data models is based on the deviance residual.

References

  • Abbott LJ, Parker F, Peters GF (2004) Audit committee characteristics and restatements. Auditing A J Pract Theor 23:69–87

    Google Scholar 

  • Agarwal A, Chadha S (2005) Corporate governance and accounting scandals. J Law Econ 48(2):371–406

    Article  Google Scholar 

  • Apostolou B, Hassell JM, Webber SA (2000) Forensic expert classification of management fraud risk factors. J Forensic Account 1:181–192

    Google Scholar 

  • Baber WR, Kang SH, Liang L (2006) Strong boards, external governance, and accounting restatement. Working paper, University of George Washington

  • Beasley MS (1996) An empirical analysis of the relation between the board of director composition and financial statement fraud. Account Rev 71:443–465

    Google Scholar 

  • Beasley MS, Carcello JV, Hermanson DR, Lapides PD (2000) Fraudulent financial reporting: consideration of industry traits and corporate governance mechanisms. Account Horiz 14:441–454

    Google Scholar 

  • Berle A, Means G (1932) The modern corporation and private property. Macmillan, New York, revised edition, Harcourt Brace and World, New York

  • Cameron AC, Windmeijer FAG (1996) R-squared measures for count data regression models with applications to health-care utilization. J Bus Econ Stat 14:209–220

    Article  Google Scholar 

  • Carcello JV, Nagy AL (2004) Audit firm tenure and fraudulent financial reporting. Auditing A J Pract Theor 23:55–69

    Google Scholar 

  • Chen HL (2002) The creditability of financial statements and the audit quality: evidence from financial restatement. Money Watch Credit Rat 43:77–86

    Google Scholar 

  • Claessens S, Djankov S, Lang LHP (2000) The separation of ownership and control in east asian corporation. J Financ Econ 58:81–112

    Article  Google Scholar 

  • Claessens S, Fan SJ, Lang LHP (2002) Disentangling the incentive and entrenchment effects of large shareholdings. Journal of Finance 57:2741–2771

    Article  Google Scholar 

  • Dechow PM, Sloan RG, Sweeny AP (1996) Causes and consequences of earnings manipulation an analysis of firms subject to enforcement actions by the SEC. Contemp Account Res 13:1–36

    Article  Google Scholar 

  • Desai H, Hogan CE, Wilkins MS (2006) The reputational penalty for aggressive accounting: earnings restatements and management turnover. Account Rev 81(1):83–112

    Google Scholar 

  • Dunn P (2004) The impact of insider power on fraudulent financial reporting. J Manage 30:397–410

    Article  Google Scholar 

  • Eisenhardt K, Bourgeois L (1988) Politics of strategic decision making in high-velocity environments: towards a midrange theory. Acad Manage J 31:737–770

    Article  Google Scholar 

  • Erickson M, Hanlon M, Maydew E (2004) Is there a Link between executive compensation and accounting fraud? Working paper, University of Chicago

  • Fama EF, Jensen MC (1983) Separation of ownership and control. J Law Econ 26:301–325

    Article  Google Scholar 

  • Fan JPH, Wong TJ (2002) Corporate ownership structure and the informativeness of accounting earnings. J Account Econ 33:401–425

    Article  Google Scholar 

  • Finkelstein S (1992) Power in top management teams: dimensions, measurement, and validation. Acad Manage J 35:505–538

    Article  Google Scholar 

  • Francis J, Khurana I, Pereira R (2003) The role of accounting and auditing in corporate governance and the development of financial markets around the world. Asia Pac J Account Econ 10:1–30

    Google Scholar 

  • Francis J, Schipper K, Vincent L (2002) Expanded disclosures and the increased usefulness of earnings announcements. Account Rev 77:515–546

    Article  Google Scholar 

  • General Accounting Office. (2002) Financial statement restatements trends, market impacts, regulatory responses, and remaining challenges

  • Haleblian J, Finkelstein S (1993) Top management team size, CEO dominance, and firm performance: the moderating roles of environmental turbulence and discretion. Acad Manage J 36:844–863

    Article  Google Scholar 

  • Hambrick D, D’Aveni R (1992) Top team deterioration as part of the downward spiral of large corporate bankruptcies. Manage Sci 38:1445–1466

    Article  Google Scholar 

  • Haw IM, Hu B, Hwang LS, Wu W (2004) Ultimate ownership, income management, and legal and extra-legal institutions. J Account Res 42(2):423–462

    Article  Google Scholar 

  • Hribar P, Jenkins N (2004) The effect of accounting restatements on earnings revisions and the estimated cost of capital. Rev Account Stud 9:337–356

    Article  Google Scholar 

  • Jensen MC, Meckling WH (1976) Theory of the firm: managerial behavior, agency costs and ownership structure. J Financ Econ 3:305–360

    Article  Google Scholar 

  • Johnson S, Boone P, Breach A, Friedman E (2000) Corporate governance in the Asian financial crisis. J Financ Econ 58:141–186

    Article  Google Scholar 

  • Klein A (2002) Audit Committee, board of director characteristics, and earnings management. J Account Econ 33:375–400

    Article  Google Scholar 

  • La Porta R, Lopez-de-Silanes F, Shleifer A (1999) Corporate ownership around the world. J Finance 54:471–517

    Article  Google Scholar 

  • La Porta R, Lopez-de-Silanes F, Shleifer A, Vishny R (2002) Investor protection and corporate valuation. J Finance 57:1147–1170

    Article  Google Scholar 

  • Lambert D (1992) Zero-inflated poisson regression, with an application to defects in manufacturing. Technometrics 34:1–14

    Article  Google Scholar 

  • Lemmon ML, Lins KV (2003) Ownership structure, corporate governance, and firm value: evidence from the east asian financial crisis. J Finance 58:1445–1496

    Article  Google Scholar 

  • Leuz C, Nanda D, Wysocki P (2003) Earnings management and investor protection: an international comparison. J Financ Econ 69:505–527

    Article  Google Scholar 

  • Loebbecke J, Eining M, Willingham J (1989) Auditors’ experience with material irregularities: frequency, nature and delectability. Auditing A J Pract Theor 9:1–28

    Google Scholar 

  • Mallette P, Fowler K (1992) Effects of board composition and stock ownership on the adoption of ‘poison pills. Acad Manage J 35:1010–1035

    Article  Google Scholar 

  • Palmrose Z-V, Richardson VJ, Scholz S (2004) Deteminants of market reactions to restatement announcements. J Account Econ 37:59–89

    Article  Google Scholar 

  • Palmrose Z-V (1988) An analysis of auditor litigation and audit service quality. Account Rev 55–73

  • Palmrose Z-V, Scholz S (2004) The circumstances and legal consequences of non-gaap reporting: evidence from restatements. Contemp Account Res 21:139–180

    Article  Google Scholar 

  • Peng L, Roell A (2004) Executive pay, earnings manipulation and shareholder litigation, AFA Philadelphia Meetings, available at http://ssrn.com/ abstract=488148

  • Pfeffer J (1981) Power in organizations. Ballinger Publishing Company, Cambridge

    Google Scholar 

  • Richardson S, Tuna I, Wu M (2002) Predicting earnings management: the case of earnings restatements. Working paper, University of Pennsylvania

  • Srinivasan S (2005) Consequences of financial reporting failure for outside directors: evidence from accounting restatements and audit committee members. J Account Res 43:291–334

    Article  Google Scholar 

  • Warfield TD, Wild JJ, Wild KL (1995) Managerial ownership, accounting choices, and informativeness of earnings. J Account Econ 20:61–91

    Article  Google Scholar 

  • WU M (2002) Restatements. Unpublished dissertation, New York University

  • Yeh YH, Woidtke T (2005) Commitment or entrenchment? Controlling shareholders and board composition. J Bank Finance 29:1857–1885

    Article  Google Scholar 

  • Yeh YH, Ko CE, Su YH (2003) Ultimate control and expropriation of minority shareholders: new evidence form Taiwan. Academia Econ Papers 31:263–299

    Google Scholar 

  • Zahra SA, Richard LP, Rasheed AA (2005) The antecedents and consequences of top management fraud. J Manage 31:803–828

    Article  Google Scholar 

  • Zahra S, Pearce J (1989) Boards of directors and corporate financial performance: areviewand integrative model. J Manage 15:291–334

    Article  Google Scholar 

Download references

Acknowledgements

Authors are grateful to anonymous reviewers for their insightful comments and suggestions. Liuching Tsai also greatly acknowledges the financial support from Taiwan National Science Council (Project No. NSC 94-2416-H-415 -006).

Author information

Authors and Affiliations

  1. Department of Accountancy and Graduate Institute of Finance & Banking, National Cheng Kung University, No. 1, University Rd, Tainan City, 701, Taiwan

    Chaur-Shiuh Young & Hui-Wen Hsu

  2. Department of Business Administration, National Chia-Yi University, 580, Sinmin Rd, Chia-Yi City, 600, Taiwan

    Liu-Ching Tsai

Authors
  1. Chaur-Shiuh Young
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. Liu-Ching Tsai
    View author publications

    You can also search for this author in PubMed Google Scholar

  3. Hui-Wen Hsu
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Liu-Ching Tsai.

Rights and permissions

Reprints and permissions

About this article

Cite this article

Young, CS., Tsai, LC. & Hsu, HW. The effect of controlling shareholders’ excess board seats control on financial restatements: evidence from Taiwan. Rev Quant Finan Acc 30, 297–314 (2008). https://doi.org/10.1007/s11156-007-0054-7

Download citation

  • Published:

  • Issue Date:

  • DOI: https://doi.org/10.1007/s11156-007-0054-7

Keywords

JEL Classifications

Search

Navigation