The effects of insider share pledging on earnings

The effects of insider share pledging on earnings management Dec 5, 2020 Sangno Lee Accounting, Jeonbuk National University Insider share pledging and earnings management 5 Dec 2020 Page 1 Insider share pledging

I. A Motivations Share pledging in Korea Insider share pledging and earnings management 5 Dec 2020 Page 2 Insider share pledging

I. A Motivations Share pledging in Korea • Share pledging of 30 business groups – 0. 4% increase of share pledging last year(9. 1%->9. 5%) – 9. 5% share pledging rate (6 trillion out of 67 trillion) – If excluded no pledging groups such as Samsung and Hyundai, 37. 4% share pledging rate • Disclosure of share pledging – Mandatory disclosure since 2009. – Shareholders who owned 5% shares (majority share holders and their special relatives). Insider share pledging and earnings management 5 Dec 2020 Page 5 Insider share pledging

I. B Research Question Do insiders who pledge their shares manipulate reported earnings? • A fall in the firm’s share prices subsequent to the pledge can be quite costly – The lender can require the insiders to pledge more shares to maintain margin levels – The lender can even liquidate the pledged shares to recover the loan, leading to a further fall in price. • Hence, insider may be motivated to increase the stock price by considering upward earnings management. • A rise in the firm’s share prices subsequent to the pledge can be quite benefit. – The insiders can diversify their risks. – The insiders do not want to abrupt increase of stock price, leading to much attentions to the firm. • Hence, insider may be motivated to smooth the stock price by considering downward earnings management. Insider share pledging and earnings management 5 Dec 2020 Page 6 Insider share pledging

I. C Literature Prior Studies • Anderson and Puleoa (2015) – Insiders’ pledging increases firm risk, extracting private benefits at the expense of outsider shareholders. • Chan, Chen, Hu, and Liu (2015) – They examine how personal share pledged by controlling shareholders affect corporate share repurchase decisions. They find that high pledge companies are more likely to repurchase especially after a significant drop in share prices. • Dou, Masulis, and Zein (2015) – When managers significantly reduce pledging, shareholders wealth increases. Insider share pledging and earnings management 5 Dec 2020 Page 7 Insider share pledging

II. A Research Design The research model • Jones (1991) • Dechow et al. (1995) • Insider shares – Share pledging / Total outstanding shares Insider share pledging and earnings management 5 Dec 2020 Page 8 Insider share pledging

II. B Research Design The research model Insider share pledging and earnings management 5 Dec 2020 Page 9 Insider share pledging

III. Sample • Manufacturing firms listed in KOSPI market over 2011 to 2014 • December fiscal year end in the sample • Source: DART, KISValue, and Data. Guide • 406 firm-year observations Insider share pledging and earnings management 5 Dec 2020 Page 10 Insider share pledging

IV. A Empirical Analysis Descriptive statistics for absolute discretionary accruals, blockhoders share pledging rate, and other firm characteristics listed in KOSPI market of Korea Exchange over the period of 2011 -2014. Insider share pledging and earnings management 5 Dec 2020 Page 11 Insider share pledging

IV. B Empirical Analysis Correlation between the variables The statistics in brackets is a significance value for the coefficients of correlations. Insider share pledging and earnings management 5 Dec 2020 Page 12 Insider share pledging

IV. C Empirical Analysis The effects of insiders share pledging on earnings management Insider share pledging and earnings management 5 Dec 2020 Page 13 Insider share pledging

IV. Discussions Main findings • As insiders increase share pledging, they tend to make earnings management although the direction of earnings management is not certain. • Foreigner’s ownership structure – Negative but not significant and almost zero. – Casting doubt about the role of foreigner’s monitoring • Governance – Correct negative sign but not significant • Firm size – Correct negative sign but not significant • Leverage – Positive and significant – Financial distress Insider share pledging and earnings management 5 Dec 2020 Page 14 Insider share pledging

IV. Discussions Main findings • Profitability – Negative and significant – Bidirectional earnings management • Age – Negative sign and significant • Big 4 – Positive sign and significant Insider share pledging and earnings management 5 Dec 2020 Page 15 Insider share pledging

V. Conclusions Contributions • We find evidence of insiders earnings management – Insiders take their benefits at the expense of outsider shareholders. – Mandatory disclosure is not enough to curb insider share pledging. – We can consider limiting voting rights to shares under share pledging like Taiwan. – The purpose of funds from share pledging is too vague. • Instead of general borrowing, we investigate personal borrowing of insider shareholders with share collaterals. Insider share pledging and earnings management 5 Dec 2020 Page 16 Insider share pledging

Insider share pledging and earnings management 5 Dec 2020 Page 17 Insider share pledging