Business group affiliation and misreporting: evidence from Korean chaebols

Abstract

While prior studies suggest that business groups actively manage their earnings, direct evidence on whether or how they ultimately violate accounting rules remains scarce. Our investigation of Korean business groups reveals a negative association between business group affiliation and detected misreporting propensity, unexpectedly signalling less detection of misreporting among group affiliates. However, further analyses indicate that misreporting complexity, captured by cases involving valuation of derivatives, private companies, and other complex financial instruments, may obscure detection of misreporting in business groups. We also find that within business groups, misreporting is disproportionately concentrated in affiliates positioned closer to controlling families on the pyramidal ownership chain, where it is more likely to benefit these controlling families. However, misreporting affiliates are rarely the ultimate parents. Overall, our findings suggest that business groups strategically balance the costs and benefits of misreporting to maximise gains for controlling owners while mitigating their exposure to legal and reputational risks.