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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Pacific-Basin Finance Journal, Volume 24, September 2013, Pages 132–155
This study investigates the endogenous relationship between abnormal insider trading and accrual abuse, and explores whether corporate governance affects this relationship. Our results suggest that insiders take advantage of private information on abnormal accruals to time their trading and manipulate accruals opportunistically to mislead the stock market prior to their planned trading. More important, we find that the abuse of inside information for stock trading becomes more serious when a firm's ultimate controller has a great divergence of control rights (or seat-control rights) from cash flow rights. We also find that higher family ownership and control, increased managerial ownership, or a dual leadership structure not only induces more private information trading prior to financial reports disclosure, but also intensifies accrual abuse for future trading. The results for composite governance indices are also consistent with our expectation. Taken together, our evidence suggests that a poor corporate governance system interacts with abnormal insider trading and abnormal accruals, thereby aggravating insider expropriation on outside investors.
Corporate insiders typically possess superior information about firm prospects to use information advantage for stock trading. Managers also have accounting discretion under the generally accepted accounting principle (GAAP) in preparing financial statements to use accounting choices to mislead the markets. Therefore, insiders have both the motivation and opportunity to take advantage of inside information to trade before the information is publicly released or to manipulate accruals for their planned trading. Several studies have attempted to investigate the relationship between insider trading and accrual abuse. These studies have indicated that managers consistently manipulate discretionary accruals to affect stock prices prior to their planned trading (Zhang, 2003, Sawicki and Shrestha, 2008 and Huang, 2010). Beneish and Vargus (2002) also suggested insider trading to be an informative signal on earnings quality and the valuation implications of accruals. In other words, insiders could take advantage of superior accrual information to trade. Even worse, they might also engage in earnings management for future trading. Therefore, exploring the relationship between insider trading and accrual abuse in an emerging market with weak investor protection is more important than that in developed markets because insiders have more opportunities to expropriate minority shareholder rights in this case. Taiwan denotes an ideal situation to investigate this issue because Taiwanese firms characterize by high-level earnings management (Leuz et al., 2003), large ownership-control separation, prevalent family-control (Yeh and Woidtke, 2005), and widespread pyramidal groups and cross-holdings (La Porta et al., 1999, Claessens et al., 2000 and Faccio and Lang, 2002). Although the Taiwan Securities Exchange Act strictly prohibits insiders from abusing undisclosed information for stock trading,1 abnormal insider transactions still occur from time to time. With accounting discretion and information superiority, insiders could make extremely abnormal returns in stock markets under weak corporate governance. Whereas prior research has discussed the effect of corporate governance on deterring earnings manipulation (Chen et al., 2007a, Chen, 2012 and Hazarika et al., 2012) or reducing abnormal insider trading (Fidrmuc et al., 2006 and Betzer and Theissen, 2009), there is little evidence on the endogenous relationship between insider trading and abnormal accruals, and the effect of corporate governance on the mentioned relationship. To fill this gap, this study employs three-stage least squares (3SLS), which combines two-stage least squares (2SLS) with a seemingly unrelated regression (SUR), to investigate the endogenous relationship between insider trading and abnormal accruals. This study specially explores how corporate governance affects the relationship between insider trading and abnormal accruals. Our empirical results show that discretionary current accruals (DCA) and discretionary accruals (DA) had a significantly positive (negative) effect on abnormal insider purchases (abnormal insider sales). These findings suggest that insiders might abuse information on high (low) accruals before it is publicly revealed and opportunistically purchase (sell) corporate stocks in advance to make subsequent abnormal returns (prevent losses) from the market. Our results also show that abnormal insider sales (purchases) had a significant and positive (negative) influence on DCA and DA. These findings indicate that insiders might deliberately report earnings upward (downward) to sell (buy) their shareholdings at a superior price after financial reports are publicly revealed. We found that firms with a large ownership-control wedge, high-family ownership, and family-board members are associated with increased insider purchase and sales related to informed abnormal DCA. Family concentration also induces insiders to exploit accounting discretion to increase (decrease) earnings so that they can sell (buy) their shareholdings at a better (cheaper) price subsequently. We also found that a higher managerial ownership and a dual-leadership structure are associated with increased insider trading due to observing abnormal accruals and more accrual management for their planned trading. These findings suggest that, when managers possess more shareholdings or a CEO is also the board chair, they have a greater opportunity to access financial information and stronger control on managing earnings, leading to increased entrenchment effects. Therefore, our results support the managerial entrenchment hypothesis of Jensen and Ruback (1983). To provide an easy method for interpreting our results, we constructed a composite governance index by estimating the first principal component of the governance variables as the proxy for firm governance quality. The results suggest that firms with a higher governance index, which indicate poor governance quality, induce insiders to abuse private information on abnormal accruals to trade prior to the financial earnings disclosure and also lead to severe earnings management for future insider trading. Again, these findings support our hypotheses, which imply that firms under a poor governance system suffer high agency costs and are more likely to abuse their control to entrench outsiders leading to great accrual abuse on private information trading and earnings manipulation. Our study contributes to the literature in several ways. First, we show that insiders not only adjust their shareholdings by abusing private information on abnormal accruals prior to the disclosure of financial reports, but they also manipulate accruals for future trading. Second, we add to the insider trading and earnings management literature by investigating the effect of corporate governance on the relationship between insider trading and abnormal accruals. We show that a poor governance system not only exaggerates abnormal insider trading related to the abuse of undisclosed abnormal accruals, but also intensifies earnings manipulation induced by their future trading. Third, we use 3SLS to explore the endogenous relationship between abnormal insider trading and accrual abuse. This method not only considers causality, but also prevents possible autocorrelation in residuals (Besley, 1988). The remainder of this paper is organized as follows: Section 2 provides literature reviews and hypotheses. Section 3 describes the research design and methodology, including data, empirical models, and variables. Section 4 reports the analysis of regression results and robustness tests. Section 5 offers a conclusion to our findings.
نتیجه گیری انگلیسی
This paper investigates the endogenous relationship between abnormal insider trading and abnormal accruals using Taiwanese data and the effect of corporate governance on this relationship. The empirical results show that DCA and DA have a significantly positive (negative) effect on abnormal insider purchase (abnormal insider sales), suggesting that insiders might take advantage of inside information on abnormal accruals to increase (decrease) their shareholdings before financial earnings are publicly reported. Conversely, these results also indicate that abnormal insider purchase (sales) has a significant and negative (positive) influence on DCA and DA, implying that insiders might deliberately use accounting discretion to manipulate reported earnings downward (upward) for future purchase (sale). More importantly, our results suggest that a large ownership-control wedge would enlarge private information trading on abnormal accruals before financial earnings are publicly reported. Taiwanese firms are prevalently dominated by controlling shareholders. When their control rights considerably surpass cash-flow rights, they are likely to abuse private information and accounting discretion to expropriate minority shareholders, to obtain trading profit for themselves. Furthermore, the results indicates that high-family ownership or control, increased managerial ownership or a dual-leadership structure not only induces additional insider trading based on their proprietary information of abnormal accruals, but also intensifies their abuse on accounting discretion for future stock trading. The findings imply that family ownership concentration induces insiders to entrench outside investors, which leads to both greater private information trading and more earnings manipulation for future trading. Furthermore, as managers possess more shareholdings or when a CEO is also the board chair, they have a greater opportunity to access financial information and stronger control on managing earnings, leading to increased entrenchment effects. The results for composite governance indices are also consistent with our hypotheses implying that firms with poor governance mechanisms are more likely to abuse their control to entrench outside investors, which leads to greater private information trading and earnings manipulation for future trading. In summary, this paper provides strong evidence of the entrenchment effect of poor governance quality on the relationship between abnormal insider trading and earnings management. The complex ownership structure of Taiwanese firms, characterized by the large ownership-control separation and high-family ownership concentration, provides controlling owners with both ability and incentive to expropriate minority shareholders through private information trading and reporting uninformative earnings. Therefore, policy-makers and regulators should understand how the ownership-control wedge and family control in East Asian corporations, such as Taiwan, provide perverse incentives for insiders to abuse private information trading and reduce accounting information quality. These findings facilitate laws and regulations reform and promote a healthy stock market.