Family Firms and Earnings Management: Empirical Evidence From India

Abstract

This study investigates the earnings management among family firms in India after taking into account the moderating the effect of board independence. Discretionary accruals have been used to measure the magnitude of earning management, which has been estimated using the Modified Jones model (1995). The proportion of independent directors in the board and CEO duality have been used as proxies of board independence. Based on a sample of 2074 companies listed in Bombay Stock Exchange (BSE) of India, spanning over 13 years from 2005 to 2017, we find that family firms are less likely to be engaged in earning management in comparison to their non-family counterparts after controlling for firm-specific variables such as firm size, financial leverage, sales growth, and operating performance. Family firms’ lower engagement in earning manipulation consistent with the notion of alignment effect rather than the entrenchment effect; there is greater alignment of interest between majority and minority shareholders in family firms due to their long-term focus. The findings also suggest that corporate governance is ineffective in India to control the financial irregularities due to a domination of management in controlling in the board, which jeopardizes the capability of independent directors to fulfill their monitoring role, consistent with managerial hegemony theory (Abdullah, 2004). In family firms, the board members have implicit ties with the dominant family, which results in a lack of substantial independence. The positions of CEO and chairman in family firms are mostly held by the family members themselves; therefore, holding these positions by the same person or two different persons, do not impact the earning management significantly. In particular, we find that family ownership limits the earnings management, which in turn, could affect their quality of financial reporting.