2.1. Controlling Shareholder and Agency Theory
This study relates to three strands of literature: corporate governance, controlling shareholder, and corporate scandals. First, agency theory serves as a fundamental theoretical background to articulate the relationships among corporate governance, controlling shareholders, and firm value. Agency problem, first introduced by Jensen and Meckling [
2], states that there might be conflicts between the interests of shareholders (i.e., principal) and employed managers (i.e., agent). Managers have the incentive and ability to maximize their own self-interest at the expense of principals. The literature on finance and accounting has explored effective and useful management control mechanisms to lessen agency costs [
3]. Since the Organisation for Economic Co-operation and Development (OECD) established its first principles of corporate governance in 1999, corporate governance has continued to expand its coverage, considering ownership structure, the roles and responsibilities of shareholders, boards of directors, and the timely and accurate disclosure of information [
5]. The literature has examined the characteristics of corporate governance, such as board size [
18,
19], board independence [
20,
21], management ownership [
22], government ownership [
23,
24], and foreign ownership [
25], that cause agency problems. However, the literature tends to agree that there is no single model of good corporate governance [
26].
Second, the ownership structure issue generates a principal–principal agency problem as conflicts between large and minority shareholders become significant [
4]. There has been a debate on the effect of concentrated ownership on agency costs. Finance literature has explored large shareholders’ role in reducing agency problems between owners and managers. Advocates for controlling shareholders state that concentrated ownership is an effective monitor of executives. Collective action and free-riding problems among dispersed and minority shareholders are believed to hamper the effectiveness of supervising managers’ behavior. In contrast, major shareholders have sufficient resources and incentives to monitor and check management decisions [
27]. Having such absolute power over executives can enhance their monitoring effectiveness [
12]. Collectively, concentrated ownership is likely to be effective in resolving a trade-off between managerial control and interest [
28]. However, an opposing view has been also receiving increasing support. The dominant shareholder has the incentive to use their controlling power in their interest by extracting private benefits, to the detriment of minority shareholders, which supports the expropriation hypothesis [
4,
11,
29]. Previous studies depict several ways of expropriation by dominant owner–managers. They can make suboptimal investment decisions through less profitable mergers and acquisitions that may not pay off for the firm [
30,
31]. Furthermore, ownership concentration may hamper the adoption of effective corporate governance mechanisms [
6]. Controlling shareholders with absolute power tend to substitute for the formal corporate governance system, decreasing the relevance of the board function [
32].
The third strand of the literature relevant to this study observes the effect of corporate scandals on firm value. However, there exist limited related studies in finance and accounting literature. Instead, much of the literature has focused on market credibility regarding corporate scandals [
33,
34]. For instance, Karpoff et al. [
34] provide evidence that accounting misconduct negatively affects firm value by decreasing market credibility. In emerging economies, there might be a greater chance for the occurrence of potential corporate scandals related to political ties than in Western economies. Hung et al. [
9] find that corporate sandals are associated with poor stock returns in China; however, the negative effect of political scandals on firm value is more significant than that of market scandals. The literature implies that the capital market might downgrade companies when detecting risks engendered by corporate scandals and the misconduct of controlling shareholders.
2.2. Hypothesis Development
There have been long-standing disputes on the repeated occurrences of controlling shareholders’ scandals (e.g., [
5]); however, there the literature has lacked in exploring how the capital market reacts to the removal and resolution of unethical controlling shareholder risks [
5,
6]. Unlike the Western capital market where ownership and management are fully separated in listed companies, controlling owner–manager issues are common in most of the other countries, including Korea, China, Vietnam and Latin America [
5,
6,
9]. This study argues that the dissolution of dominant shareholders’ risks (due to imprisonment) enhances affiliated firms’ value; furthermore, corporate governance positively moderates the effect.
The finance literature has examined controlling shareholders’ role in mitigating agency problems between owners and managers. Collective action and free-riding problems among dispersed and minority shareholders are believed to hamper the effectiveness of supervising managers’ behavior. In contrast, major shareholders have sufficient resources and incentives to monitor and check management decisions [
27]. Ownership concentration creates a principal–principal agency problem. For instance, Grossman and Hart [
35] are concerned that major shareholders tend to use their controlling power for their interests, which leads to disadvantages for the minority shareholders. Previous studies have provided empirical evidence on the negative effect of ownership concentration concerning controlling shareholders on firm value [
35,
36,
37,
38,
39]. In emerging economies, ownership concentration is also likely to increase agency costs, which lowers firm value in the capital market [
6,
40,
41,
42]. Such phenomena are generally delineated in the managerial entrenchment hypothesis [
43,
44]. These results imply that the dissolution of controlling shareholders might decrease ownership concentration and agency costs, enhancing their firm value.
The principal–principal agency problem is a serious issue wherein the dominant controlling shareholders act as owner–managers. For instance, Korean chaebols have interlocking-ownership structures among subsidiaries that preserve family control despite low direct ownership [
45]. In other emerging economies, such as China, Vietnam, and Brazil, a small number of controlling shareholders tend to have significant and excessive influence on affiliated firms even though these companies are publicly traded [
1,
5,
6,
46]. Fan and Wong [
47] provide evidence that the controlling shareholders in Asian firms are likely to take advantage of minority shareholders by adjusting profits and limiting information usability. Dominant controlling shareholders may also manipulate information disclosure to hide their self-dealings [
1,
48]. A largely dispersed ownership structure effectively reduces information asymmetry problems than the ownership concentrated on the dominant shareholder [
49]. The controlling shareholders in emerging economies are believed to have stronger control over affiliated firms, which implies that firm value can be more vulnerable to the controlling decision-makers. This study labels this situation as the “controlling owner–manager risk” because uncertainties regarding controlling shareholders might negatively affect the related firms. Affiliated firms under the control of such dominant shareholders might be undervalued and traded at a discount. Collectively, the evanishment of controlling owner–manager risk increases firm value [
50].
This study has comprehensively reviewed empirical evidence on the effect of controlling shareholders’ misconduct in Korea. Many previous studies on this topic have supported an argument that the absolute power’s unethical behavior negatively affects firm value. For example, So [
51] finds that some Korean companies’ cumulative excess returns, whose executives had been accused of embezzlement and breach of duty, were negative. Lee and Joe [
14] report that foreign investors react to corporate scandals with concern. The proportion of foreign shareholders plummeted after reports on corporate scandals such as embezzlement, dereliction of duty, illegal fundraising, and unfair trade were published. These companies’ excess returns reportedly decreased shortly after these adverse events but recovered in the long run. However, such results cannot be generalized because some recent studies with a large sample of data provided mixed results. For instance, Lee and Choi [
10] analyze several Korean companies whose owner–managers were convicted for embezzlement but find no significant consequence. It is noteworthy that the capital market’s reactions to these owner–managers’ convictions vary among affiliated companies.
In general, dominant and controlling shareholders are extremely common among large conglomerates, and they have significant and excessive control over affiliated companies, putting them at the controlling owner–manager risk. The evanishment of unethical controlling shareholders might be an opportunity to dissolve owners’ uncertainty and decrease agency costs, generating a positive response from the capital market. These arguments lead to the following hypothesis.
Hypothesis 1 (H1). The removal of unethical controlling shareholders due to imprisonment is positively associated with the affiliated firms’ value in the capital market.
This study proposes a contingency model to depict the effect of the controlling shareholder’s evanishment by considering the moderation of corporate governance as a proxy for professional managers’ discretionary decision-making power. Good corporate governance facilitates communication between shareholders and management by ensuring managerial autonomy and shareholders’ involvement. It consists of various dimensions, including soundness and independence of the board of directors [
52,
53,
54,
55]. First, the board of directors should be organized to represent various shareholders’ interests beyond the interest of a specific group of shareholders. The soundness of the shareholder structure indicates that corporate governance is systemized to prevent the excessive influence of a small number of controlling shareholders and reduce biased decisions [
56]. Second, the independence of board activities and the fairness of the shareholders’ resolution process should be secured to help guarantee their appropriate supervision and monitoring, such that distorted managerial decision-making (for the interest of managers and a limited number of shareholders) does not occur [
21,
26]. Collectively, good corporate governance is likely to secure general shareholders’ and investors’ interest by encouraging managers to utilize corporate resources more efficiently.
The literature highlights the positive effect of good corporate governance on firm value. For example, Bushman and Smith [
57] and Klapper and Love [
58] provide empirical evidence that effective governance contributes to corporate performance and market value by reducing information asymmetry and balancing the interests of internal and external shareholders. Dittmar and Mahrt-Smith [
59] also suggest that firms with poor corporate governance dissipate cash quickly in ways that significantly reduce operating performance. Previous studies of the Korean capital market provide consistent results that corporate governance positively affects firm value and rational decision-making about finance [
42,
56,
60,
61]. Good corporate governance systems that secure a sound board structure and independent board activities lower the excessive influence of a conglomerate’s controlling shareholder over its affiliated firms. As such, the managers’ autonomy and decision-making powers are not threatened. It could possibly be a form of empowerment given to professional managers. Being protected by independent boards, managers are likely to allocate corporate resources more efficiently, thereby enhancing firm performance in Korea [
62,
63,
64].
The managers of such affiliated firms have the discretionary power to make appropriate managerial decisions on ordinary days. However, the controlling shareholders may have intentions of increasing their leverage on each affiliated firm, undermining corporate governance and restricting competent managers’ abilities [
6,
32]. We argue that corporate governance may represent the discretionary power of the executive managers of affiliated firms being independent of the controlling shareholders’ excessive influence. The absence of dominant controlling shareholders’ power paradoxically alleviates their overusing power and reinforces the discretionary power of the employed manager, which is called the “autonomy effect” in this study.
The recent literature on digital transformation and innovation addresses how digital and technological innovation affects corporate governance (e.g., [
65]). Recent digital innovations, including artificial intelligence, machine learning, and big data, have improved the visibility of management systems and reduced agency costs. For instance, the knowledge application of professional managers accentuates the positive impact of knowledge management on firm innovation, which increases managers’ discretion without increasing agency costs [
66,
67]. Moreover, inbound open innovation and machine learning increase the discretionary power of managers, enabling them to actively invest in products, processes, and business innovation [
68]. In general, digital transformation is positively associated with corporate governance and firm value [
69].
Collectively, corporate governance, representing a sound and independent corporate structure, can intensify the autonomy effect of managers and thus accentuate the positive effect of the dissolution of unethical controlling shareholders’ risks on firm value. These arguments lead to the following hypothesis.
Hypothesis 2 (H2). Corporate governance positively moderates the relationship between the absence of unethical controlling shareholders due to imprisonment and firm value.