Regression Model Hypothesis Methodology

1903 As auditors reputation becomes higher, the value of RAM will decrease. For the auditor will try to decrease the degree of earnings management to elevate his or her own reputation. In addition, we expect the magnitude of RAM will tend to decrease as the size of the auditor group increases, since the scale of an audit company or partnership is considered to elevate audit quality. As the cost of the owner ‘s equity of an audited corporation increases, an increase in RAM is also to be expected because the information asymmetry between management and other information users gets larger, which results in a reduction in the credibility of the financial statements and makes it difficult to detect RAM, one of the causes making for asymmetries of information. In the above table, our expectation for the predicted sign of the size of discretionary accruals is a question mark. The reason is as follows: DAM and RAM are tools for \ the measurement of earnings management for accruals and for the measurement of cash flows from operating activities, respectively, which results in their innately negative - relationship. In many prior research papers, it was found that these two variables are negatively correlated Zang, 2006, Cohen, 2008. But, when there is the possibility that the manager uses both DAM and RAM for earnings management, is not unreasonable to expect these two variables to have a positive + relationship. Meanwhile, some variables like a term dummy, an industry dummy, the leverage of liabilities LEV, the asset size of a firm SIZE and the growth rate of total assets otherwise equity Predicted Sign - - - - - + ? + - + 1904 GROW, all of which are considered to influence the size of RAM, are also included in this model as control variables. DeFond and Jiambalvo 1994 claim that if the debt leveraging is increasing, managers will tend to increase their reported income. According to Watts and Zimmerman 1986, the larger the size of a firm, the greater the likelihood of its being a political target; an increase in political costs provides managers with an incentive to underreport accounting profits. When deducing the size of the firm SIZE, sales are usually used, but in this study, the logarithm of total assets is applied because t strong correlations exist between real activities manipulation RAM and sales amounts. Soonseok Yoon 2001 explained that if the growth rate of the firm GROW is high, managers will be inclined to report higher returns for tax purposes. We use the annual growth rates of total assets as proxies for growth patterns. 4. Results 4.1 Sample selection The sample consists of all firms with available financial data from TS-2000 Korea Listed Companies Association. The sample includes non-financial firms that are traded on Korea Stock Exchange and KOSDAQ. We exclude firms in the financial industry because accounting rules are different for these firms. And the sample includes annual data for firms covering years from 2003 to 2007. The final sample consists of 5,222 firm- year observations. 4.2 Empirical Results 4.2.1 Descriptive statistics 1905 Table 1 represents the descriptive statistics of RAM and its components for the each year covered by this study. Contrary to our expectations, CFO has slightly positive coefficients. Coefficients of production costs PROD and discretionary expenses DE are positive and negative, respectively, which is consistent with our expectations. Every component moves in direction consistent with RAM from 2003 to 2007, but the values of the coefficients do not keep up increasing or decreasing in the time series [as time goes by]; this indicates that the Accounting Reform Act, which was introduced in 2003, has hardly any influence on the size or direction of earnings management. Panel A: Annual Descriptive Statistics of RAM Year Components of RAM Total RAM CFO Prod DE Average Standard Deviation Average Standard Deviation Average Standard Deviation Average Standard Deviation 2003 0.035 0.197 0.842 0.641 -0.033 0.181 1.121 0.765 2004 0.791 4.046 8.961 31.46 -0.007 0.090 8.905 31.313 2005 0.081 0.378 1.234 1.313 -0.030 0.171 1.344 1.420 2006 0.030 0.213 0.866 0.657 -0.028 0.165 1.087 0.738 2007 0.010 0.199 0.824 0.647 -0.026 0.161 1.096 0.717 Panel B: RAM and Its Components Description Average Standard Deviation Min Value Max Value CFO 0.04572 0.14824 -1.03023 59.34589 PROD 1.79811 0.63668 -0.09344 8.13855 DE -0.02698 0.02767 -1.00000 0.00300 RAM 1.00843 0.66321 0.01153 8.51596 DAM -0.00063 0.21721 -4.75608 5.98581