기억의 이익 상향조정 경향 및 경영성과와 사외이사의 임기 중 자발적 사임 = The Association between Income-increasing Earnings Management and Operating Performance, and Voluntary Resignation of Outside Directors

다국어 초록 (Multilingual Abstract)

This study investigates the association between income-increasing earnings management, operating performance, and the probability of voluntary resignation of outside directors, without disclosing the reasons for the resignation, during the term of outside directorship. Board of directors should monitor the behaviors of managers and controlling shareholders, and restrict any unethical, illegal, or other problematic activities of them. If outside directors face the conflict with management or inside directors due to the disagreement over earnings management or feel uncomfortable with poor financial performance, it is possible that outside directors resign from the board voluntarily during their terms of outside directorship in order to avoid any potential legal liability or the reputation loss that can be caused by those behaviors. This study aims to investigate this issue. Firms listed on the Korean stock market are required to include outside directors at least a quarter of board members. The rule was adopted in 1998, after Asian financial crisis of 1997, with the purpose of improving the corporate governance mechanism in Korea. The rule has been expanded since then (Kwon et al. 2012). The outside directors are supposed to monitor the opportunistic behaviors o management or controlling shareholders and protect minority shareholders (Shleifer and Vishny 1997; La Porta et al. 1999). For example, Klein (2002) reports that the independent outside directors decrease the level of income-increasing earnings management in the U . S. However, there have been several criticisms in Korea on whether the outside directors play a significant role in restricting firms` or controlling shareholders` opportunistic behaviors. If managers or controlling shareholders try to perform any problematic behaviors, outside directors need to restrict them. In the process, different opinions or conflicts can occurs. As a result, it is possible that outside directors resign from the firm if he is not able to persuade the managers or controlling shareholders to give up such activities (Fahlenbrach et al. 2010, Asthana and Balsam 2009). It is because such behaviors would increase the legal liability that the outside directors need to face or may damage their reputation (Srinivasam 2005). This tendency can be more prominent when firms try to manipulate earnings to report higher net income (i.e., by engaging in income-increasing earnings management ; Klein 2002), and when operating performance is poor or financial risk is high (Skinner 1994; Fahlenbrach et al. 2010). With 4,399 firm-year observations collected from KOSDAQ(Korea Securities Dealers Automated Quotaion) market over the period from 2004 to 2010, we empirically test these predictions. Among the samples, 622 observations (14.1%) contain voluntary outside director resignations during their respective terms without any specific and detailed reasons. The remaining samples experience no such resignations. The empirical results are summarized as follows. First, the probability of outside director resignation increases as firms engage in more income-increasing earnings management, but the results are sensitive to the measures for the discretionary accruals. Thus, the finding is weak at best. It is well known that an income-increasing earnings management increases the potential legal liability of firms and thus that of outside directors. Second, the probability increases as the firm`s operating performance, which is measured by return on assets, is poor. It implies that the outside directors` potential legal liability increases when the operating performance becomes worse. Third, the probability increases further when firms engage in income-increasing earnings management and when the firms` operating performances are poor simultaneously. The results suggest that the potential risks for outside directors increase further when both an income-increasing earnings management and a poor operating performance occur at the same time. These findings provide several interesting and valuable insights to regulators, academics, investors, and other interested parties. Given that almost no studies have investigated the incentives of outside directors to resign from the board voluntarily, this study provides valuable intuitions. Especially, this paper`s findings suggest that the regulators need to consider expanding disclosure requirements on the reasons for the outside director resignation. More detailed disclosures on the reasons would benefit outside interested parties. We hope future studies to look into this issue further in details.