Ownership structure, internal governance and earnings management in Hong Kong

Abstract

This study examines whether ownership structure and internal governance mechanisms are associated with earnings management in Hong Kong. We hypothesize that the earnings management of a firm is associated with the ownership structure including ownership concentrations, different ownership concentration levels of family held companies and substantial institutional investors; and internal governance mechanisms including firms that are audited Big 4 auditors and proportion of outside directors. The non-discretionary accruals are measured using modified Jones model with crosssectional basis. We employ multivariate model to investigate the relationship between discretionary accruals and various independent variables. Our results show that discretionary accruals are positively associated with high/low level of family ownership and negatively related to firms that are audited by Big 4 auditor as hypothesized. Our results reveal that the controlling shareholders in family businesses can expropriate minority shareholders by accounting manipulations and that independent nonexecutive directors cannot effectively constrain opportunistic earnings management. This requires regulators and standard setters to improve the extent of investor protection and to increase the independence of outside directors on the board.