Income Smoothing in Family-Controlled Companies: Evidence from Italy

Abstract

Manuscript Type: Empirical Research Question/Issue: This paper focuses on the relationship between one of the main corporate governance dimensions – ownership structure – and income smoothing. The paper investigates whether family-controlled companies differ from non-family-controlled companies with respect to income smoothing. Due to different incentives of management and owner investment horizons, we hypothesize that income smoothing is less likely among family-controlled companies than among non-family-controlled companies. Additionally, we hypothesize that among family-controlled firms income smoothing is less likely when CEO and Board Chairman are members of the controlling family. Various definitions of “family control” are applied. A sample of Italian listed companies is used for the empirical analysis. Research Findings/Insights: We find evidence that income smoothing is less likely among family-controlled companies than non-family-controlled companies. Moreover, among family-controlled companies, income smoothing is less likely for firms whose CEO and Board Chairman are members of the controlling family. Theoretical/Academic Implications: This paper fills a gap in the literature, suggesting that not only the level of ownership concentration or insider ownership but also the nature of the dominant shareholder (family versus non-family) should be considered when addressing the motivations for income smoothing. Furthermore, our findings indicate that agency theory and stewardship theory are complementary in explaining the role played by family control in income smoothing decisions. While in non-family-controlled companies the traditional owner-manager agency problems tend to prevail and motivate income smoothing, in family-controlled companies such agency issues become less relevant and a stewardship attitude emerges, rendering income smoothing less likely. Practitioner/Policy Implications: This study is of interest to financial statement users, including analysts and investors, as it shows that different company types (e.g., family versus non-family) have a different attitude towards income smoothing. In particular, these results aid users in interpreting the company's reported profitability and its potential variability. The conclusions also are of interest to auditors when evaluating the reliability of the reported income of companies characterized by various ownership structures.