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Business Ethics and Financial Reporting Quality: Evidence from Korea

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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.

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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

P it–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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Authors and Affiliations

  1. KDI School of Public Policy and Management, Seoul, Korea

    Tae Hee Choi

  2. Korea University Business School, Seoul, Korea

    Jinhan Pae

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  1. Tae Hee Choi
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  2. Jinhan Pae
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Correspondence to Jinhan Pae.

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Choi, T.H., Pae, J. Business Ethics and Financial Reporting Quality: Evidence from Korea. J Bus Ethics 103, 403–427 (2011). https://doi.org/10.1007/s10551-011-0871-4

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