Ownership Concentration, Client Importance, and Earnings Management: Evidence from Pakistani Business Groups

Abstract

The purpose of this study is to investigate the earnings management behavior in Pakistani business groups by empirically testing the impact of ownership concentration as well as client importance on earnings management. A novel measure for client importance is proposed. This measure uses information on whether the business group is using the same auditor for two or more of its affiliates. The study finds a positive impact of group affiliation on earnings management. However, this relation is weak during the energy-crisis period, suggesting an increased reliance of Pakistan business groups on external capital markets and a redistribution of external financing through transactions on group-internal capital markets. The findings also reveal efficient earnings management in non-family business groups as well as in independently operated family firms. Moreover, there seems to be a positive and non-linear relation between group affiliate’s ownership concentration and earnings management. The presence of institutional investors constrains the business groups from earnings management and this is mainly due to the proportion of domestic institutional investors. Finally, the results indicate a statistically significant positive relation between client importance and earnings management in family-owned business groups. This result is not sensitive to the size of the auditor firm used.