Family ownership and earnings management

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Family ownership and earnings management

Name: Jenneke Swart Student Number: 10672621

Thesis supervisor: Dr. A. (Alexandros) Sikalidis Date: 25-06-2018

Word Count: 14050

MSc Accountancy & Control, variant Accountancy

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Statement of Originality

This document is written by student Jenneke Swart who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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Abstract

This study investigates the effect of family firm ownership on the levels of earnings management for U.S. listed firms. The agency theory, the socioemotional wealth theory and prior literature is used to compute expectations about the effect of family ownership on earnings management. Prior literature shows that family firms experience less type 1 agency problems since there is no separation of ownership and management. Family firms have a good monitoring function, value sustainability and value their reputation. Family members have long-term incentives because they want to pass their business to future generations and would therefore avoid actions that hinder future value and reputation. Different studies provided evidence that family firms perform better and have higher reporting quality compared to non-family firms. Therefore, the use of earnings management would be less likely in non-family firms compared to non-family firms. To investigate this, the relevant data of a sample of the S&P 500 including family firms and non-family firms is used and multiple regressions analysis have been performed. Evidence is found that family firms are less likely to use earnings management conducted through reduction of non-operational expenses and overproduction. The results in this study indicate that family firms are less likely to use real activities based earnings management compared to non-family firms. No evidence is found for accrual-based earnings management. These findings suggest that ownership structures, in particularly family ownership, influence financial reporting and managerial behavior in firms.

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1. Introduction

In most countries around the world, between 70 and 95% of all businesses are family businesses. The European Family Businesses (EFB) states that family businesses are important and also research about family businesses is important, because family firms represent a large stake of the businesses in the world. They argue that prior research has shown that this form of enterprise has benefits to the economy and society at large. However, they state that there is a lack in quantitative research about family businesses. One of the reasons for this lack is the difficulty in defining and identifying family firms. (EFB, 2012). As a response to this publication, this study will focus on family firms and in particularly on family firms and the use of earnings management.

When an organization has a family ownership structure, there are potential benefits and costs regarding this structure (Anderson & Reeb, 2003). In prior literature, different theories about family firm ownership were examined. Wang (2006) and Ali and Chen (2007) state that the concentrated ownership gives family members the opportunity and incentive to expropriate wealth from outside investors. This is called the type 2 agency problem by Ali et al. (2007) and Wang (2006) describes this problem as the entrenchment effect. On the other hand, family members are expected to have aligned incentives with their own family, and since the value of the firm is closely related to the wealth of the family, the family and other shareholders are expected to be also better aligned (Wang, 2006). Family members have long-term incentives because they want to pass their business to future generations. Therefore they are more aware about family reputation which creates incentives for less opportunistic behavior (Gomez-Meija, Hynes, Nunez-Nickel & Moyano-Feuntes, 2012). The type 1 agency problem, explained by Ali et al. (2007), can be explained as follows. Family members usually hold important positions on both the management team and the board of directors, which reduced the agency problem between ownership and management due to better monitoring. In addition, there is another theory applicable for family firms, the socioemotional wealth theory. The socioemotional wealth theory considers that the goal of a family firm is to keep itself intact and leave it to the next generation of the family (Martin, Campbell & Gomez-Mejia, 2016). In summary, the effect of family ownership on managerial behavior, earnings management, can work in both ways.

Research about the effect of family ownership on firm performance and earnings quality has already been carried out more often, for example by Wang (2006), Ali et al. (2007) and Anderson and Reeb (2003). Therefore, in this study the focus will be on earnings management.

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Achleitner, Geunther, Kaserer and Siciliano (2014) investigated the effect of family ownership on earnings management for German listed firms, including real-based earnings management. Martin et al. (2016) investigated the accrual-based earnings management decision between family firms and non-family firms for U.S. listed firms. They suggest that, based on the socioemotional wealth theory, potential reputational consequences of earnings management lead family members to engage in less earnings management relative to non-family members. Wang (2006) and Martin et al. (2016) both found evidence for less accrual-based earnings management in family firms. To make a contribution, this study will investigate whether family firms compared to non-family firms engage in more or less earnings management for U.S. listed firms, including real activities-based earnings management. This is examined by using the following research question:

RQ: What is the effect of family ownership on earnings management?

To examine this question, a multiple regression analysis is executed with a sample of U.S. listed companies containing family and non-family firms. Both real activities based earnings management and accrual-based earnings management are used to measure earnings management. Real activities based earnings management is measured by three different measures and a summary measure following Roychowdhury (2006). Accrual-based earnings management is measured by the modified Jones model according to Dechow, Sloan and Sweeney (1995). Consistent with the expectations the results indicate less real activities based earnings management in family firms compared to non-family firms. The results show that family firms report less operational costs and more non-operational expenses, indicating less use of real activities based earnings management. No evidence is found that family firms use less sales manipulation, however the summary measure does provide evidence that indicates less use of real activities based earnings management in family firms. Overall, it can be concluded that family firms are less likely to use real activities based earnings management. No significant evidence is found for a difference in discretionary accruals. This means that no evidence is found for a difference in use of accrual-based earnings management between family firms and non-family firms.

The paper is structured as follows. Chapter 2 contains the literature review with prior literature and theories. In chapter 3, the hypotheses are developed. Chapter 4 describes the research design with its sample and models. Chapter 5 contains the results and chapter 6 concludes this study.

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2. Literature review

This study is related to family ownership literature, the agency theory, the socioemotional wealth theory and prior earnings management literature. In the following subparagraphs, this literature will be discussed to provide an understanding of the theory and to develop hypotheses in chapter 3.

2.1 Family ownership

Many different definitions of a family firm are used in the literature. The general understanding is that in a family firm the family has influence. The question is, to what extent does the family has influence. Harms (2014) states that family business studies do not build on one unified definition. He argues that when there will be a more broadly accepted family firm definition, the research will become more reliable and statistically proved which family firms can benefit from due to probable increased reputation of family firms. But on the other hand, family firms are presented in all kinds of forms, so therefore it is difficult to define family firms by a narrow definition or maybe it isn’t even possible. In most countries around the world, between 70 and 95% of all businesses are family businesses (EFB, 2012). The European Commission states that 60% of all companies in Europe are family businesses. They acknowledge that family business range from sole proprietors to large international enterprises and are big or small, listed or un-listed, etc. Because family firms play such a significant role in the European economy, the European Commission requires the following definition of a family business within four elements: “(1) The majority of decision-making rights are in the possession of the natural person(s) who established the firm, or in the possession of the natural person(s) who has/have acquired the share capital of the firm, or in the possession of their spouses, parents, child, or children’s direct heirs; (2) The majority of decision-making rights are indirect or direct; (3) At least one representative of the family or kin is formally involved in the governance of the firm; (4) Listed companies meet the definition of family enterprise if the person who established or acquired the firm (share capital) or their families or descendants possess 25 per cent of the decision-making rights mandated by their share capital” (EC, 2009). However, in the U.S. and in accounting research, there is no common understanding of a family firm. Berrone, Cruz and Gomez-Meija (2012) also argue that family firms are not a homogeneous group of people with the same interests and that family businesses are not identical with respect to organizational

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characteristics and behaviors. They show a methodological gap in capturing the effect of family ownership when using the level of ownership as family firm indicator. For instance, sentiments, emotions, and relationships within family firms may vary from one firm to another and, within the firm, from one point in time to another.

Prencipe, Markarian and Pozza (2008) define family firms as companies in which one or more families linked by kinship, close affinity, or solid alliances hold a sufficiently large share of capital to enable them to make decisions regarding strategic management. In their research they classify Italian listed companies as family ﬁrms when the dominant family owns, directly or indirectly, more than 50% of the equity capital, or the dominant family controls the strategic decisions of the ﬁrm. So, the influence of the family in family firms is related to being able to influence decision-making or make decisions regarding strategic management. Anderson and Reeb (2003) express their concern about the identification of family firms in research. They choose to use the fractional equity ownership of the founding family and the presence of family members in the board of directors. In this study the fractional equity ownership is used, following Anderson and Reeb (2003).

The main difference between family and non-family firms is the separation of ownership and control in their ownership structure. In family firms there is often no clear distinction between ownership and management and sometimes ownership and management are integrated. In non-family firms there is this clear distinction. This difference in ownership structure is investigated in prior literature. Anderson and Reeb (2003) argue that family firms tend to have family members on high management positions and these family members are likely to have a strong relation with the company’s well-being and therefore are more in line with company’s interests, which reduces agency conflicts. Also, Klein, Shapiro and Yong (2005) state that due to difference governance structures that commonly characterize family firms, the alignment between managers and shareholders’ interests is better within family firms. On the other hand, Anderson and Reeb (2003) argue that there are also potential costs for family ownership. They state that founding-family ownership and control in public U.S. firms is perceived as less efficient and less profitable. Combining ownership and control allows concentrated shareholders to exchange profits for private benefit and this is harmful for other outside shareholders. This shows that the effect of the different ownership structure can work both positively and negatively for the firm. In the following paragraph theory and prior research about the effects of family ownership are explained. The type 1 and type 2 agency problems regarding family firms are explained. Thereafter, the entrenchment effect and the alignment

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effect according to Wang (2006) are discussed, and finally the socioemotional wealth theory from Gomez-Meija et al. (2007) is discussed.

2.2 Agency theory and family ownership

Jensen and Meckling (1976) state that the separation of ownership and control results in agency costs. They provide the agency theory and explain it as follows. It is defined as a contract under which one or more persons (the principal) engage another person (the agent) to perform some service on their behalf which involves delegating some decision making authority to the agent. But, because both parties want to maximize their own utility and they have different interests it is possible that the agent will not act in best interest of the principal. In other words, the separation of ownership and control is the source of the problem of misalignment of interest between the agent and principal. This theory holds for conflicts between all kind of stakeholders (principals) and management (agent). These problems can result in two kinds of costs. The principal can try to establish appropriate incentives for the agent and incur monitoring costs to control the activities of the agent. On the other hand, it can result in the agent paying bonding costs to guarantee that he will not take certain actions that would harm the principle and to ensure that the principal is aware and secured for that. Also, there will be a residual loss, explained by the view that there will always be some divergence between the agent’s decision and those decision which would maximize the welfare of the principal (Jensen and Meckling, 1976). Eisenhardt (1989) describes that the agency theory is concerned with resolving problems that can occur in the agency relationship, explained as the contract between the principal and the agent. The problems arise from conflicts of goals and different attitudes toward risk between the principal and the agent when it is difficult or expensive for the principal to verify the actions of the agent. This corresponds with the explanation of Jensen and Meckling (1976). Eisenhardt (1989) explains that the agency theory is about determining the most efficient contract governing the principal-agent relationship given the assumptions about people, organizations and information. Particularly, the focus of the theory is on the question whether a behavior-oriented contract or an outcome-behavior-oriented contract is more efficient.

Since the main difference between family firms and non-family firms is the different ownership structure, wherein family firms there is no clear separation between ownership and control. This implies that family firms may not experience the same agency problems that arise from the principal-agent relationship in non-family firms. Family firms are likely to experience

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fewer agency costs compared to non-family firms with a clear separation of ownership and control.

Ali et al. (2007) distinguish two main types of agency problems in public firms. The first type of agency problems arises from separation of ownership which may lead to managers not acting in the best interest of shareholders. The second agency problem arises between non-controlling shareholders resulting in non-controlling shareholders seeking private benefits at the expense of non-controlling shareholders.

Wang (2006) distinguishes the agency problem in family firms into one potential positive and one potential negative effect, resulting into two theoretical definitions. The entrenchment effect is the effect that concentrated ownership in family ownership firms creates incentives to expropriate wealth from other shareholders and the opportunity to manage earnings. On the other hand, the alignment effect is the effect that the concentrated ownership in family firms creates greater monitoring and controlling possibilities which is more efficient. It creates long-term employee loyalty and the family name and reputation is important which will lead to less opportunistic behavior.

Gomez-Mejia et al. (2007) developed the socioemotional wealth theory (SEW) to understand earnings management in family firms from another perspective than only the agency theory. The notion of this theory is that family firms value the sustainability of the business and that they will avoid actions that hinder future value. Family firms find it important to retain the family reputation because the goal of a family firm is to keep itself intact and leave it to the next generation of the family.

In this study, the agency theory applied for family firms is narrowed into the following two types: (1) conflicts of interest between shareholders and management, and (2) the conflicts of interest between controlling shareholders and non-controlling shareholders. Besides these two types of agency problems, the entrenchment effect and the alignment effect suggested by Wang (2006) will be furtherly discussed and the socioemotional wealth theory from Gomez-Mejia et al. (2007) will be further explained.

2.2.1 Shareholders and management

The first type of agency problems exists between shareholders and management. The agency problems arise due to the separation of ownership and management. This can be explained by management wanting to maximize their personal wealth and shareholders wanting to maximize the value of the firm (Ali et al. 2007). Jensen and Meckling (1976) suggest the use of incentive

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contracts to align management’s interest with the interests of shareholders. When these compensations contracts are tied to components that determine firm value, the interests can be realigned. However, incentive contracts have to be made up very carefully because it will not work if management will take actions that do not lead to higher firm value (Eisenhardt, 1989). This means that an incentive contract can lead to earnings management when compensations are tied to earnings.

Ali et al. (2007) provide characteristics of family firms that possible reduce the agency conflicts. Family members can be in the position to influence and monitor the firm because family members can hold important positions in both management team and the board of directors. Also, family members tend to have good knowledge about the activities of the firm, which enables good monitoring. If family members are both in the position as owner and manager, this would imply more aligned incentives which would result in less type 1 agency problems (Ali et al., 2007). Anderson and Reeb (2003) note that combining ownership and control, in large concentrated family firms, can be advantageous when shareholders act to mitigate managerial expropriation. Family members have longer investment horizons which means that families have incentives to make long-term investment decisions. Ali et al. (2007) found better reported earnings quality for family firms compared to non-family firms, suggesting less agency problems in family firms. The results of Anderson and Reeb (2003) imply that family ownership reduces agency problems regarding decision-making efficiency. Prencipe et al. (2008) also uses a theoretical background based on the agency theory and argue that the traditional owner-manager agency conflict is mitigated in family firms due to greater monitor ability.

So, in family firms it is likely that family members are spread throughout different positions in the firm. Families can be active as management, in board of directors and as shareholders, due to these positions and due to their incentives it is likely that monitoring is of high quality in family firms compared to non-family firms. This implies that family firms experience less agency problems that arise from conflicts of interest between owners and managers.

2.2.2 Controlling and non-controlling shareholders

The second type of agency problem exists between controlling and non-controlling shareholders, it can be explained as the problem that concentrated ownership creates incentives for controlling shareholders to expropriate wealth from other shareholders. Controlling

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shareholders are the shareholders that have substantial control over the decisions-making in the firm (Ali et al., 2007). Anderson and Reeb (2003) argue in line with the agency problem between controlling and non-controlling shareholders that controlling shareholders have the incentives and power to take actions that benefit themselves at the expense of other shareholders. This can be explained by the notion that large concentrated shareholders may derive greater benefits from firm growth, technological innovation, or firm survival relative to enhancing shareholder value. When families are controlling shareholders in family firms, families are able to benefit themselves at the expense of other claimants by expropriating wealth from the firm through compensations plans, related-party transactions, or special dividends only for the family (Anderson & Reeb, 2003). Management may pursue actions that benefit the interest of the family, but these actions may potentially result in suboptimal performance for the firm. Gopalan and Jayaraman (2012) argue that insiders in insider controlled firms, like family firms, usually have concentrated ownership and enjoy disproportionate control rights. This, in combination with lack of intervention from outside shareholders, can lead to autonomy over decisions for insiders in the firm. They state that this gives insiders the opportunity to expropriate wealth from outside shareholders through operating and financing decisions. This is in accordance with the type 2 agency problem. In combination with the ability of insiders to influence financial disclosures, Gopalan and Jayaraman (2012) find that insider controlled firms are more likely to be associated with earnings management than non-insider controlled firms.

An important tool to mitigate the type 2 agency problems are the legal protection rights for minority shareholders to minimize rent extraction by controlling shareholders (Ali et al., 2007). Continental European countries tend to have less legal protection rights than in the U.S., where minority shareholders have strong legal protection (Ali et al., 2007). Gopalan and Jayaraman (2012) find that insider controlled firms are only associated with more earnings management in countries with low protection rights.

This implies that family firms experience agency problems regarding the minority shareholders because it is likely that families in family firms are controlling the business. This means that family firms have the opportunity to expropriate wealth from outside shareholder for the maximization of their own wealth. However, this problem can be mitigated due to the strong legal protection for minority shareholders in the United States.

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Wang (2006) distinguishes two effects: the entrenchment effect and the alignment effect. Both effects are between controlling and non-controlling shareholders in family firms. The concentrated ownership gives power to seek private benefits at the expense of other shareholders. Since family members in family firms are the controlling shareholders and family firms therefore experience concentrated ownership, this theory can be applicable for family firms. It implies that family members may manage earnings for their private benefits from the firm at the cost of minority shareholders, this is defined as the entrenchment effect. Prencipe et al. (2008) argues that when top executive managers are members of the controlling family, this can give rise to agency problems between controlling family and minority shareholders. Even when top executive managers aren’t family members, they can be closely monitored and influenced by the family members. In correspondence with the entrenchment effect, this gives the opportunity to controlling family members to expropriate wealth from minority shareholders by opportunistic behavior. The entrenchment effect is corresponding with the type 2 agency problem following Ali et al. (2007), discussed in the prior sub-paragraph.

On the other hand, Wang (2006) argues the possibility of the alignment effect. Due to the assumption that in family firms there is a great, long-term presence of family members in both ownership and management, the interests of families and other shareholders could therefore be better aligned. This notion is defined as the alignment effect. The wealth of family firms is mostly dependent to the value of the firm which creates strong incentives to monitor employees. Also, the long-term view of family firms discourages opportunistic earnings management behavior because that kind of activities are short-term oriented and can even be harmful for long-term performance. For example Anderson and Reeb (2003) find that family firms perform better and have stronger corporate governance compared to non-family firms. This implies that the long-term view and reputation concerns constrain family firms to involve in opportunistic behavior for private gains (Wang, 2006).

2.2.4 Socioemotional wealth theory

Looking further than only the agency theory, Gomez-Meija et al. (2007) developed the socioemotional wealth theory. They argue that family firms are not only concerned with financial returns but also with their socioemotional wealth. Socioemotional wealth refers to the need of certain non-financial aspects of the firm. For example identity, ability to exercise family

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influence and the perpetuation of the family. The theory implies that family firms attach more importance to long-term value and sustainability of the business than to short-term earnings. In their study, Gomez-Meija et al. (2007) argue that family firms are willing to accept a significant risk to their performance, to avoid losses of their socioemotional wealth. At the same time, they avoid risky business decisions that might aggravate that risk. They show that family firms may be risk willing and risk averse at the same time. In the study from Martin et al. (2016), which is also conducted by Gomez-Meija, the earnings management decision between family firms and non-family firms is examined. They suggest that family members will weigh the potential loss of socioemotional wealth, related to earnings management, against the potential benefits of earnings management. Where the potential costs of earnings management are, for example, the costs of being caught which can lead to fines and more important, reputation damage. The damaging impact of earnings management on reputation is important in family firms because of three reasons: (1) Reputation of the firm represents the reputation of the family; (2) Earnings management takes a long time to be exposed and family firms are usually for the long-term, and; (3) Earnings management is gambling with a big risk. Their findings suggest that potential reputational consequences of earnings management, following the socioemotional wealth theory, lead family members to engage in less earnings management than non-family firms (Martin et al., 2016). However, their focus is only on accrual-based earnings management. In this study, the focus will also be on real activities based earnings management. Achleitner et al. (2014) also use the socioemotional wealth theory in their study that investigates the effect of family firms on earnings management for German listed firms. The socioemotional wealth theory would predict that family firms are less likely to take actions that would consume real resources in the long run, since it is important to maintain the business for future generations.

2.3 Earnings management

Earnings management is a well-known subject within accounting. Lots of prior research exists about earnings management, for example by Roychowdhury (2006), Klein (2002), Cohen & Zarowin (2010), Walker (2013) and Kim, Park and Wier (2012). Healy and Wahlen (1999) define earnings management as the use of judgement in financial reporting in structuring transactions to modify financial reports to either influence contractual outcomes that depend on reported earnings or to mislead some stakeholders about the underlying economic performance of the company. Prencipe et al. (2008) state that managers exercise discretion in the preparation of financial statements and use accounting to affect earnings levels to achieve smooth earnings.

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Earnings management can be carried out by using the flexibility in accounting standards about recording transactions and measuring the value of assets and liabilities. Because the application of certain standards contain estimations and it is the task of managers to make these assessments, earnings management can be performed within the standard rules. Walker (2013) provides a broader definition of earnings management: “The use of managerial discretion over (within GAAP) accounting choices, earnings reporting choices, and real economic decisions to influence how underlying economic events are reflected in one or more measures of earnings” (Walker, 2013, p. 446). This definition does not presume that all earnings management is bad and it does not include fraudulent accounting choices, although high levels of earnings management are often prior to fraud. This definition also includes real economic decisions, indicating that earnings management does not just consist of accrual-based earnings management.

Prencipe et al. (2008) find that the main incentives of earnings management are debt covenants, bonus plans and income smoothing. Managers have incentives to manage earnings to avoid the violation of covenants in debt contracts, by increasing earnings when they are close to violating these covenants based on profitability. Second, managers have incentives to maximize their compensation and this leads to earnings management when their bonus-plan is related to profitability. Third, managers will avoid fluctuations in their reported earnings and especially avoid reporting a decreasing in earrings. This means that when the profitability is lower compared to the previous year, managers tend to engage in earnings management to increase their earnings and to report smoother results. The main purpose of earnings management is therefore to influence contractual outcomes (Prencipe et al. 2008). Walker (2013) identified the following three principal sets of motives that influence the earnings management decisions: “(1) To achieve contractual terms or targets related to reported earnings; (2) To influence the information set used by external investors and/or information intermediaries used to form expectations of future cash flows and/or perceptions of firm risk; and (3) To influence the information set of third parties with an interest in the firm’s financial strength: current or potential competitors, customers, suppliers, workers, regulators, pressure groups, politicians etc.” (Walker, 2013, p. 457). This is corresponding with the motives of Principe et al. (2008). Income smoothing is to influence external investors or third parties and debt covenants and bonus compensation plans are examples of contractual terms and targets related to earnings.

Understanding the desire to engage in earnings management is understanding management’s incentives according to Dechow and Skinner (2000). In particular, they conclude

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that managers have strong incentives to beat benchmarks and boost stock prices in case of equity issue. Dechow et al. (2000) state that earnings management depends on managerial intent. In accordance with Walker (2012), Dechow and Skinner (2000) state that to some extent, managing earnings is desirable to better reflect the economic performance of a business. Earnings management is therefore defined as the abuse of the flexibility in accounting to hide actual financial volatility (Dechow & Skinner, 2000).

Managing earnings can be done in a variety of ways, from cutting expenditures or carrying out special transactions to manipulating accruals. Therefore, earnings management can be divided into real activities based earnings management (REM), based upon operational decisions, and accrual-based earnings management (AEM), based upon accounting choices regarding financial reporting. In this study there will be a distinction between these two types. Zang (2012) investigated the trade-off decision between these two types. The following sub-paragraphs will explain the two types of earnings management and the trade-off decision.

2.3.1 Real activities based earning management

Roychowdhury (2006) states that besides managing earnings by manipulation of accruals with no direct cash flow consequences, managers also have incentives to manipulate real activities. He defines real activities manipulation as a practice where managers deviate from normal operational practices with the goal to enable managers to meet reporting goals and to mislead stakeholders. In other words, intentionally change the timing and structure of operational, investment and financing decisions to manage earnings. Real activities manipulation can reduce firm value because of the negative effect on cash flows in future periods due to increasing earnings in the current period. Real activities based earnings management is therefore associated with greater long-term costs for the company. Graham et al. (2005) observe that earnings are perceived as most important metric, not cash flows. They find that managers are willing to manipulate real activities to meet certain earnings targets even though the manipulation potentially reduces the value of the firm. These earnings targets are for example hitting benchmarks or smoothing the earnings. Zang (2012) describes real activities manipulation as a purposeful action with suboptimal business consequences by altering reported earnings in a particular direction by changing the timing or structuring of operations, investments or financing transactions.

Roychowdhury (2006) provides three manipulation methods for real activities based earnings management. Real activities based earnings management might be conducted through

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sales manipulation, reduction of discretionary expenses and overproduction. Cohen and Zarowin (2010) provide an explanation for these methods. Sales manipulation can be used through price discounts and milder credit conditions and will cause increases in sales volume. When the product price reverts to old levels, negative consequences may arise such as lower firm value. Discretionary expenses include R&D, advertising and SG&A expenses. Deferring these expenses will increase current earnings and lower cash outflows, however, this does not lead to direct profit and deferring these expenses will negatively affect the future earnings. Managers can also involve in overproduction to manage earnings upwards. With higher production levels, cost of goods sold are lower and there will be higher operating margins. But, overproduction will lead to abnormally high production costs and therefore has a negative effect on the cash flows and earnings (Cohen and Zarowin, 2010).

2.3.2 Accrual-based earnings management

Accrual accounting is the use of basic accounting principles such as revenue recognition and matching revenue’s and costs for better assessment of the entity’s economic performance. Accruals represent the difference between operating cash flow and the reported net income. This difference exists due to recognizing revenue’s and costs that are related to a certain financial year, in net income, when the related cash flow is at another moment. The goal is to recognize the revenue’s and costs in the period in which they have occurred. Accrual-based earnings management involves booking the costs and revenues higher or lower than they actually are. Because of the flexibility in the accounting standards, managers can use these accruals to manipulate the financial statements (Dechow & Skinner, 2000). Zang (2012) states that accrual-based earnings management can be achieved by changing the accounting methods or estimates used when presenting a transaction in the financial statements. Without changing the underlying transaction, the reported earnings can be biased in a particular direction.

Accrual-based earnings management has no direct influence on the cash flow because it consists of shifting costs and revenue’s in time. Accruals influence the profit for a certain financial year, but not affect the total profit (Roychowdhury, 2006).

In this study, the modified Jones model from Dechow et al. (1995) will be used to measure accrual-based earnings management based on the absolute value of discretionary accruals. In this model, positive firm-year discretionary accruals are indicative that management has used their discretion to manage their earnings upwards. The modified Jones model assumes that al changes in credit sales result from earnings management based on the

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assumption that it is easier to manage earnings by exercising discretion over the recognition of revenue on credit sales than over the recognition on cash sales. The portion of total accruals unexplained by the firm’s economic condition are discretionary accruals and these discretionary accruals are assumed to be caused by accrual-based earnings management. Kim et al. (2012), Roychowdhury (2006), Wang (2006) and Martin et al. (2016) also use the modified Jones model to measure accrual-based earnings management. They follow Dechow et al. (1995) in the assumption that lower discretionary accruals for family firms indicate lower use of income increasing earnings management.

Achleitner et al. (2014) also expect more negative discretionary accruals for family firms than non-family firms. However, they state that negative discretionary accruals indicate the use of earnings-decreasing accrual-based earnings management by family firms. They use the socioemotional wealth theory to predict that family firms would report inflated earnings and apply conservative accounting choices in order to survive on the long-term by retaining the firm’s value. Klein (2002) states that both high positive or negative discretionary accruals indicate the use of accrual-based earnings management. Negative discretionary accruals resulting into lower earnings can be the result of lowering the purchase price in management buyouts, managing earnings-based bonuses and avoiding regulatory actions. Positive discretionary accruals can be the result of raised stock prices for seasoned equity offerings, initial public offerings and stock-financed acquisitions. In this study, only the use of income-increasing earnings management will be investigated.

2.3.3 Trade-off decision

Zang (2012) investigates the trade-off decisions between real activities based earnings management and accrual-based earnings management. He argues that managers use real activities based earnings management and accrual-based earnings management as substitutes to achieve a desired earnings amount. He finds evidence for a trade-off decision that is influenced by the costs and timing of earnings. First, regarding the costs of the two types of earnings management tools, he states the following. Accrual-based earnings management is constrained by scrutiny from outsiders, like high-quality auditors, and the available flexibility in the accounting systems. Real-activities manipulation can be costly because it is unlikely that it increases a firm’s long-term value or it can even damage a firm’s long-term value. Also, real activities based earnings management is constrained by the monitoring of institutional investors. Because institutional investors are more likely to have a better understanding of a

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firms operating decisions. The second argument Zang (2012) provides for the trade-off decision is timing. When managers use real business decisions to manage their earnings, they do not control the whole outcome of that decision. Managers can only make rough estimates of the impact of their decision and at the end of the year the real outcome will be revealed. When the realized amount of real manipulation is lower or higher than the anticipated amount, managers can still use accrual-based earnings management to alter the earnings at the fiscal year-end. This suggests that managers can use accrual-based earnings management to “fine-tune” their accruals after fiscal year-end based on the realized real activities based earnings manipulations. Cohen and Zarowin (2012) emphasize that the distinction between real activities based earnings management and accrual-based earnings management is important, because real activities based earnings management has direct cash flow consequences where accrual-based earnings management has not. Also, the presence of an auditor, auditor tenure and being in a high-litigation industry are associated with the use of real activities based earnings management.

Graham, Harvey and Rajgopal (2005) find evidence for this trade-off decision. They find that managers indicate a greater willingness for real activities based earnings management rather than accrual-based earnings management. The two possible reasons for that are: (1) Accrual manipulation is more likely to be scrutinized by auditors and regulators due to greater probability of detection, and; (2) The possible amount to manipulate accruals at year-end is limited which creates a risk that the reported income falls below the threshold.

Cohen, Dey and Lys (2008) and Kim et al. (2012) find evidence that suggests that firms substitute between real activities based earnings management and accrual-based earnings management. Firms that engage in real activities based earnings management are less likely to engage in accrual-based earnings management and the other way around.

This indicates that managers, based on their preferences and the circumstances, make a trade-off decision between the two types of earnings management. The decision to use one or both of these two types of earnings management is based on the relative costliness for the managers and the firm. Since family members in family firms are expected to have other incentives than employees in non-family firms, this can influence their decision on the use of earnings management methods.

In the following chapter, the hypotheses will be developed regarding the expectations about the use of both earnings management methods within family firms compared to non-family firms.

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3. Hypothesis development

To develop the hypotheses the different theories and prior research are taken into account. The hypotheses will be used to answer the following question: “what is the effect of family firm ownership on earnings management?” This can be answered by investigating the difference in use of earnings management between family firms and non-family firms. Since earnings management is distinguished in real activities based earnings management and accrual-based earnings management, there are two separate hypotheses regarding each method.

Real activities based earnings management is defined as the manipulation of real activities by changing the timing and structure of operational and/or financial practices to manage earnings (Roychowdhury, 2006). Real activities based earnings management has direct effect on cash flows, can reduce firm value and therefore, it can even damage a firm’s long-term value (Zang, 2012; Cohen & Zarowin, 2012). Motives for earnings management can be income smoothing, debt covenants and bonus compensation plans (Principe et al., 2008). Ali et al. (2007) argues that family firms experience less agency type 1 problems between owners and managers since family firms often have no separation of management and ownership. Also, family firms are in a better monitoring position (Principe et al., 2008). However, still the type 2 agency problems would suggest that management may pursue actions that benefit the interest of the family, but these actions may potentially result in suboptimal performance for the firm (Anderson & Reeb, 2003). The socioemotional wealth theory (Gomez-Meija et al., 2007), states that the family firms value the sustainability of the business and family reputation. Since real activities based earnings management has a negative effect on the firm’s operational performance and family firms would avoid activities that attach the sustainability of the company. Based on the theory, real activities based earnings management would be less likely in family firms compared to non-family firms. The following hypotheses will be tested to investigate this expectation:

H1 – Family firms are involved in less real activities based earnings management compared to non-family firms

Achleitner et al. (2014) found for German listed firms that family firms exhibit less real activates based earnings management than non-family firms. Continental European countries tend to have less legal protection rights than in the U.S., where minority shareholders have

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strong legal protection (Ali et al., 2007). Gopalan and Jayaraman (2012) find that insider controlled firms are only associated with more earnings management in countries with low protection rights. So, for this study, it can be interesting to see if this hypothesis will hold in the U.S., with strong legal protection.

Accrual-based earnings management is the use of flexibility in accounting principles to manipulate the reported earnings without direct influence on the cash flows (Roychowdhury, 2006). The agency theory predicts less type 1 agency problems. Since family members are usually owners and managers at the same time, it implies aligned incentives and it could enable good monitoring (Ali et al., 2017). Also Wang (2006) argues that due to the assumption that in family firms there is a great, long-term presence of family members in both ownership and management, the interests of families and other shareholders could therefore be better aligned. However, the type 2 agency problems according to Ali et al. (2007) and entrenchment effect according to Wang (2006) predict more agency problems in family firms. The concentrated ownership gives power to seek private benefits at the expense of other, minority shareholders. However, this problem can be mitigated due to the strong legal protection for minority shareholders in the United States.

Zang (2012) and Graham et al. (2005) state that accrual manipulation is more likely to be scrutinized by auditors and regulators due to greater probability of detection. Following the socioemotional wealth theory, potential reputational consequences of earnings management lead family members to engage in less earnings management than non-family firms. When accrual-based earnings management is likely to be detected, it could imply that family firms would engage less in accrual-based earnings management. Wang (2006), Achleitner et al. (2014) and Martin et al. (2016) find that family firms are associated with lower levels of abnormal accruals, indicating less accrual-based earnings management. Therefore, the expectation is that family firms are less likely to engage in accrual-based earnings management. The following hypothesis is used to test this expectation:

H2 – Family firms are involved in less accrual-based earnings management compared to family firms

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4. Research design

The empirical approach used in this study is archival research. A multiple regression analysis is used to investigate whether the amount of earnings management statistically differs between family firms and non-family firms. First, the sample selection and collection will be explained. Second, the empirical models and all its variables that will be used for the regression are provided.

4.1 Sample selection

The difference in earnings management between family and non-family firms is examined in this study. To identify family firms, the dataset from Anderson’s website (Anderson, 2012) is used. This dataset contains the 2000 largest U.S. companies (in terms of total assets) from 2001 until 2010, including a dummy variable that indicates whether a firm is family owned. Financial companies are not included in the dataset due to their complex company profile. This results into 16,200 firm-year observations. The Compustat Fundamentals Annual database from the Wharton Research Data Services (WRDS) system are used to gather all the data that is needed to compute the earnings management variables and the control variables. Deleted from the sample are firm-year observations of which no data are available and winsorization is used to reduce the effect of possible outliers. Outliers of the variables were treated by setting the smallest percentile (1) equal to the smallest value of the 2nd percentile and the largest percentile (100) equal to the largest value of the 99th percentile. The sample is for most variables almost equally distributed. In total there are 6,952 firm-year observations, of which 1,724 are family firms and the other 5,228 are non-family firms.

4.2 Empirical models

The level of earnings management will be investigated in the context of family ownership. To examine earnings management, accrual-based earnings management and real activities based earnings management are distinguished and the empirical models with the relevant variables will be discussed in the next sub-paragraphs.

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Family ownership (FF) is the independent variable and is operationalized through a dummy variable that equals 0 in case of no family ownership and 1 in case of family ownership. The definition of family ownership used in this study is the same as presented in the dataset from Anderson’s website (2012). Fractional equity ownership is used and a firm is considered family owned if a single family possess a stake of at least 5% in the firm.

4.2.2 Dependent variables

Dependent variables in this research are proxies for real activities based earnings management (REM_PROXY) and accrual-based earnings management (ABS_DA). For both types of earnings management there will be a separate regression analysis.

4.2.2.1 Real activities-based earnings management

Following Roychowdhury (2006), the level of real activities based earning management is measured based on three methods. Real activities based earnings management might be conducted through sales manipulation, reduction of discretionary expenses and overproduction. If the firm would manage its earnings by increasing them by one of these methods, this would be reflected in their numbers. The cash flows from operations would turn out abnormally low, the discretionary expenses would be abnormally low and the production costs abnormally high. To detect earning management, the following three measures are used: (1) abnormal levels of operating cash ﬂows (R_CFO); (2) abnormal production costs (R_PROD); and (3) abnormal discretionary expenses (R_EXP). To examine the abnormal levels of cash flows from operations (CFO), production costs and discretionary expenses, the formula for normal levels is used. Both Achleitner et al. (2014) and Roychowdhury (2006) provide the following explanations about the execution of these earnings management methods.

Sales manipulation is defined as an attempt to temporarily increase sales (Roychowdhury, 2006). To increase current earnings, managers can reduce prices or extend milder credit terms towards the end of the year to accelerate sales from the next year into the current year. This causes a loss in future profitability and lowers the cash flows per dollar of sales in the current period resulting into negative discretionary cash flow from operations

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(Achleitner et al., 2014). Normal cash flows from operations is expressed as a linear function of sales and change in sales in the current period (Roychowdhury, 2006).

Another method to increase current earnings is decreasing production costs, e.g. cost of goods sold, in any period by overproducing. Increased production can result into reduced fixed costs per unit, by spreading fixed overhead costs over a larger number of units. Normal production costs contain the costs of goods sold and change in inventory. Normal production costs is expressed as a linear function of sales in the current year, change in sales in the current year and change in sales in the previous year (Roychowdhury, 2006; Achleitner et al., 2014).

Also, decreasing non-operating expenses such as research- and development costs, selling, general and administrative expenses is a method to reduce current earnings. Reducing these payments in cash will result in negative discretionary expenses in the current period, which indicates earnings management. Normal discretionary expenses are expressed as a function of lagged sales (Roychowdhury, 2006; Achleitner et al., 2014).

The following functions expresses the normal levels of CFO, production costs and discretionary expenses (Roychowdhury, 2006). The residuals (the error term) of these functions represent the abnormal levels of these measures.

(1) CFOt Assetst-1 = ∝0+ ∝1 1 Assetst-1+ ∝2 Salest Assetst-1+∝3 ∆Salest Assetst-1+ εt (2) PRODt Assetst-1 = ∝0+ ∝1 1 Assetst-1+ ∝2 Salest Assetst-1+∝3 ∆Salest Assetst-1+ ∝4 ∆Salest-1 Assetst-1+ εt (3) DISEXPt Assetst-1 = ∝0+ ∝1 1 Assetst-1+ ∝2 Sales_t-1 Assetst-1+ εt Where:

CFO_t = cash flows from operations for year t

DISEXP_t = discretionary expenses: the sum of research- and development expenses, selling, general & administrative expenses for year t

PROD_t = production costs: the sum of cogs and change in inventory for year t Assets t-1 = total assets for year t-1

Sales_t = net sales for year t Sales_t-1 = net sales for year t-1

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∆Sales t = change in net sales for year t

∆Sales t-1 = change in net sales for year t-1

All variables are deflated by lagged assets to control for scale differences. An ordinary leas squares (OLS) regression is used to compute the error terms of each function to compute the abnormal amounts of CFO (R_CFO), production costs (R_PROD) and discretionary expenses (R_EXP). Following Cohen et al. (2008), an overall summary measure of real activities based earnings management is computed in order to capture the comprehensive effect of all these three variables. The summary measure from the Kim et al. (2012) paper is used. This measure is a bit different from the Cohen et al. (2008) paper, it will decrease as firms engage in more real activities based earnings management. The measure, COMBINED_REM, is defined as the sum of the three measures, COMBINED_RAM = (R_CFO – R_PROD + R_EXP) (Kim et al., 2012). If results are consistent with hypothesis 1, the family firm variable (FF) will be positively related with R_CFO, R_EXP and COMBINED_REM, and negatively related to R_PROD, indicating less real activities based earnings management in family firms.

4.2.2.2 Accrual-based earnings management

Following the modified Jones model from Dechow et al. (1995), accrual-based earnings is measured based on the absolute value of discretionary accruals. Discretionary accruals are the difference between normal accruals and actual accruals. To estimate discretionary accruals, the formula for normal discretionary accruals is used. The model estimates normal accruals as the change in revenue minus the change in receivables, and the level of property, plant, and equipment (PPE). They control for changes in accruals that arise from changes in the firm’s normal operating activities (Roychowdhury, 2006). The residual (error term) in the following function represents the abnormal level of discretionary accruals (ABS_DA). Also in this formula the variables are deflated by lagged assets to control for scale differences.

(4) Total Accrualst-1 Assetst-1 = ∝0+ ∝1 1 Assetst-1+ ∝2 (∆REV_t- ∆REC_t) Assetst-1 +∝3 PPE_t Assetst-1 + εt

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Where:

Total Accruals = income before extraordinary items minus operating cash flows for year t

Assets_t-1 = total assets for year t-1 ∆REV t = change in revenues for year t

∆REC_t = change in revenues for year t

PPE_t = gross property, plant and equipment for year t

If results are consistent with hypothesis 2, the family firm variable (FF) will be negatively related to the absolute value of discretionary accruals (ABS_DA), indicating less income increasing accrual-based earnings management in family firms.

4.2.3 Models

To examine the differences in earnings management between family firms and non-family firms, a multivariate analysis is performed using the following regression models. These models contain the dummy variable for family firms and all control variables. The models are based on the models used by Kim et al. (2012). The first model is used to test hypothesis 1. The REM_PROXY will be replaced by the three real activities based earnings management measures and the summary measure (COMBINED_REM). This will result in four OLS regressions. The second model is used to test hypothesis 2.

Model 1 REM_PROXY = ∝0 + ∝1 FF + ∝2 SIZE + ∝3 ROA + ∝4 LEERAGE +

∝5 GROWTH + ∝6 LOSS + ∝7 RD_INT + ∝8 BIG4

Model 2 ABS_DA = ∝0 + ∝1 FF + ∝2 SIZE + ∝3 ROA + ∝4 LEVERAGE +

∝5 GROWTH + ∝6 LOSS + ∝7 RD_INT + ∝8 BIG4

Where:

FF = dummy variable equal to one if firm is family firm and zero if firm is non-family firm

ABS_DA = absolute value of discretionary accruals

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COMBINED_REM = R_CFO – R_PROD + R_EXP

R_CFO = the level of abnormal cash flows from operations R_PROD = the level of abnormal production costs

R_EXP = the level of abnormal discretionary expenses

SIZE = the natural logarithm of total assets at the end of year t ROA = return on assets (net income/total assets), at the end of year t LEVERAGE = leverage (total liabilities/total assets), at the end of year t GROWTH = growth rate in sales for the year t

LOSS = dummy variable equal to 1 if net income is negative (= loss) and equal to 0 is net income is positive (gain), for the year t

RD_INT = R&D intensity (R&D expense/sales), at the end of year t

BIG4 = dummy variable equal to 1 if the firm is audited by a big4 auditor and equal to 0 if not.

4.2.4 Control variables

Seven control variables are used to control the factors that may affect the level of earnings management and to control for potential differences between family and non-family firms. SIZE controls for the potential effect of size on the choice of earnings management. Big listed firms are often more scrutinized by financial analysts and are therefore expected to use less earnings management (Kim et al., 2012). ROA, return on assets, controls for the potential effect of profitability and performance on the choice of earnings management. Achleitner et al. (2014) found that more profitable firms engage in more earnings management. The same applies for GROWTH (Achleitner et al., 2014). Growing firms tend to use more earnings management. When firms with growth opportunities and high performance miss earnings thresholds, they are more penalized by the stock market and it is also likely that they experience more pressure to meet other earnings thresholds (Roychowdhury, 2006). LEVERAGE controls for the association of debt covenant violation with the choice of earnings management. High leveraged firms that are close to debt covenant violation may use earnings management. LOSS controls for the effect of a loss on the choice of earnings management. It is a dummy variable indicating a negative income with 1. Firms with losses are expected to engage in more earnings management to decrease the loss or to increase the loss since the damage is already done. On

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the other hand, Wang (2006) finds that firms that report losses engage in less earnings management. This can be explained by the notion that when firms already reports a loss, there is no need to manage earnings upwards. RD_INT controls for the association between R&D intensity and earnings management. Kim et al. (2012) found that firms with high R&D intensity are more likely to engage in real activities based earnings management. BIG4 controls for the potential effect of using a big four auditor on the choice of earnings management. Achleitner et al. (2014) and Kim et al. (2012) found that firms audited by the big four are associated with less earnings management.

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5. Results

5.1 Descriptive statistics

Table 1 presents the summary of the financial characteristics of the full sample (Panel A). In order to show the difference between family and non-family firms, table 1 presents the summary of financial characteristics of family firms (Panel B) and non-family firms (Panel C) separately. The table shows some differences in the earnings management measures between family and non-family firms. To examine if the differences in these means are significant, a t-test is performed for all variables including the control variables. The results of this t-test are shown in table 2.

Both family firms and non-family firms have one average positive discretionary accruals, whereas non-family firms report lower accruals. The difference in means is significant at 0.01 level, which indicates that non-family firms report lower accruals indicating less use of accruals to manage earnings. The means of abnormal cash flows from operations, abnormal discretionary expenses and the summary measure are positive for family firms and negative for non-family firms. This indicates that non-family firms have lower abnormal cash flows from operations and lower abnormal discretionary expenses compared to family firm. This could indicate, based on the expectations of the manipulation methods, that non-family firms use more sales manipulation to manage their earnings. However, this difference is not significant for abnormal cash flows from operations according the t-test. The difference in means from abnormal discretionary expenses is significant at 0.1 level and the difference. This indicates that family firms reduce non-operating expenses to report higher earnings. A lower summary measure indicates more use of real activities based earnings management and the difference in means of the summary measure is significant at 0.05 level. Which indicates less real activities based earnings management in family firms. The mean of abnormal production costs is negative for family firms and positive for non-family firms and the difference in mean is significant at 0.01 level according the t-test. This indicates that on average, family firms report lower abnormal production costs relative to non-family firms, indicating less real activities based earnings management with regard to abnormal production costs.

With respect to the differences in real activities based earnings management, family firms tend to engage in less real activities earnings management. On the other hand, the t-test shows that family firms are more likely to use accrual-based earnings management. However,

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30 Table 1. Descriptive characteristics

Panel A: Descriptive characteristics full sample (N = 6,952)

Variables Mean St. dev Median Min p25 p75 Max

FF 0.2480 0.4319 0 0 0 0 1 ABS_DA 0.0142 0.1445 0.0343 -0.7817 -0.0151 0.0762 0.3478 R_CFO -0.0001 0.0895 0.0003 -0.2917 -0.0461 0.0517 0.2443 R_PROD 0.0005 0.1702 0.0174 -0.5156 -0.0990 0.1124 0.4234 R_EXP -0.0005 0.1786 -0.0291 -0.2811 -0.1324 0.0935 0.6470 COMBINED_REM -0.0011 0.3656 -0.0512 -0.9574 -0.2538 0.2066 1.4069 SIZE 7.2224 1.5290 6.9771 4.3320 6.0849 8.1425 11.6039 ROA -0.0036 0.1727 0.0387 -0.9513 -0.0193 0.0773 0.2447 LEVERAGE 0.5009 0.2580 0.4892 0.0654 0.3091 0.6443 1.3960 GROWTH 0.0735 0.2446 0.0638 -0.5538 -0.0408 0.1618 1.1250 LOSS 0.3037 0.4599 0.0000 0.0000 0.0000 1.0000 1.0000 RD_INT 0.1008 0.1386 0.0482 0.0006 0.0150 0.1434 0.8890 BIG4 0.9384 0.2404 1.0000 0.0000 1.0000 1.0000 1.0000

Panel B: Descriptive characteristics family firms (N = 1,724)

ABS_DA 0.0215 0.1458 0.0376 -0.7817 -0.0088 0.0843 0.3478 R_CFO 0.0012 0.0874 0.0036 -0.2917 -0.0464 0.0533 0.2443 R_PROD -0.0101 0.1810 0.0123 -0.5156 -0.1135 0.1141 0.4234 R_EXP 0.0054 0.1865 -0.0235 -0.2811 -0.1350 0.1049 0.6470 COMBINED_REM 0.0167 0.3803 -0.0343 -0.9394 -0.2479 0.2349 1.4069 SIZE 6.6926 1.2654 6.4924 4.3320 5.7974 7.4497 11.6039 ROA -0.0034 0.1713 0.0375 -0.9513 -0.0158 0.0754 0.2447 LEVERAGE 0.4545 0.2528 0.4438 0.0654 0.2548 0.6004 1.3960 GROWTH 0.0770 0.2387 0.0655 -0.5538 -0.0394 0.1639 1.1250 LOSS 0.2900 0.4539 0.0000 0.0000 0.0000 1.0000 1.0000 RD_INT 0.0886 0.1255 0.0384 0.0006 0.0129 0.1282 0.8890 BIG4 0.9031 0.2959 1.0000 0.0000 1.0000 1.0000 1.0000

Panel C: Descriptive characteristics non-family firms (N = 5,228)

ABS_DA 0.0118 0.1440 0.0326 -0.7817 -0.0167 0.0734 0.3478 R_CFO -0.0005 0.0902 -0.0008 -0.2917 -0.0460 0.0510 0.2443 R_PROD 0.0040 0.1664 0.0204 -0.5156 -0.0915 0.1121 0.4234 R_EXP -0.0024 0.1758 -0.0313 -0.2811 -0.1313 0.0904 0.6470 COMBINED_REM -0.0069 0.3604 -0.0545 -0.9574 -0.2543 0.1992 1.4069 SIZE 7.3971 1.5678 7.2128 4.3320 6.2381 8.3869 11.6039 ROA -0.0036 0.1732 0.0390 -0.9513 -0.0208 0.0784 0.2447 LEVERAGE 0.5162 0.2579 0.5053 0.0654 0.3291 0.6581 1.3960 GROWTH 0.0724 0.2465 0.0627 -0.5538 -0.0410 0.1613 1.1250 LOSS 0.3081 0.4618 0.0000 0.0000 0.0000 1.0000 1.0000 RD_INT 0.1048 0.1424 0.0517 0.0006 0.0162 0.1472 0.8890 BIG4 0.9501 0.2178 1.0000 0.0000 1.0000 1.0000 1.0000

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Table 1. Notes: This table provides summary statistics for the main variables for firm-year observations from fiscal years 2001-2010. Panel A reports summary for the whole sample (N = 6,592). Panel B reports summary statistics for family firms (N = 1,724). Panel C reports summary statistics for non-family firms (N = 5,228). All numbers are rounded up to fourth decimal places.

∗∗∗ indicate significance at the 1% level. ∗∗ indicate significance at the 5% level. ∗ indicate significance at the 10% level.

there could be numerous other factors affecting these results. Since the analysis above was performed without the input of control variables, no conclusions can be made with respect to the hypotheses. Therefore, the following sub-paragraph will provide the multivariate analysis.

Table 3 presents the correlations between variables. To examine the correlations between the dependent and independent variables both Spearman rank correlations test and the Pearson correlation test are executed. The discretionary accruals and real activities based earnings management proxies are significant correlated with most of the control variables, this

Table 2. T-test for significant differences in means

Mean difference Significance (2-tailed)

ABS_DA -0.0097 0.0076*** R_CFO -0.0017 0.2509 R_PROD 0.0141 0.0014*** R_EXP -0.0078 0.0573* COMBINED_REM -0.0236 0.0100** SIZE 0.7045 0.0000*** ROA -0.0002 0.4832 LEVERAGE 0.0617 0.0000*** GROWTH -0.0046 0.2486 LOSS 0.0181 0.0779* RD_INT 0.0162 0.0000*** BIG4 0.0469 0.0000***

Notes: This table provides the results of the t-test for significant differences in means of the main variables between family firms and non-family firms. The mean difference is calculated by subtracting the non-family firm mean from the family firm mean (mean (0) – mean (1). The main variables arise from firm-year observations from fiscal years 2001-2010. The sample consists of 6,592 firm-year observations. All numbers are rounded up to third decimal places.

∗∗∗ indicate significance at the 1% level. ∗∗ indicate significance at the 5% level. ∗ indicate significance at the 10% level.

Family ownership and earnings management