Corporate Governance and Earnings Management in Family-Controlled Companies

Abstract

The corporate governance literature advances the idea that certain aspects of a board of directors’ structure improve the monitoring of managerial decisions. Among these decisions are a manager’s policies about managing earnings. Prior studies have shown that earnings management in widely held public companies is less prevalent when there is a high level of board independence. However, there is less evidence regarding the effectiveness of board independence on earnings management in family-controlled companies. This issue is particularly interesting as such companies are susceptible to various types of agency concerns. It is the purpose of this study to shed light on the earnings management issue in family-controlled companies characterized by potentially lower board independence and a higher risk of collusion. In this study, board independence is estimated by two parameters: (1) proportion of independent directors on the board; and (2) lack of chief executive officer (CEO)–board chairman duality function.Our empirical results provide evidence that the impact of board independence on earnings management is indeed weaker in family-controlled companies. The same result also holds for the lack of CEO– board chairman duality function. Such effects become stronger in cases in which the CEO is a member of the controlling family.