Paradox of Familiness: Evidence from Earnings Management in Korean Family Firms

Abstract

Extant literature offers that the alignment of ownership and controls presumably resolves the agency problem. However, traditional governance mechanisms are limited to resolve agency problems in family firms where interests of family owners and managers are aligned but conflicting with those of other shareholders. Drawing on the principal-principal perspective and the social embeddedness, we develop a theoretical framework to address the agency problems in family firms. Specifically, we theorize different earnings management behaviors between non-family and family firms, and under what conditions family owners and managers engage in earnings management. We also propose a business group, independent board, and dissimilarity in top manager functional backgrounds as governance mechanisms to monitor earnings management in family firms. We investigate the earnings management practices of 570 Korean family and non-family firms from 2002 to 2010. We find that, in general, family firms are less likely to engage in earnings management than non-family firms. However, we also find that the higher the level of family embeddedness through ownership, the more earnings management a family firm will commit. In addition, we confirm that business group affiliations and independent boards attenuate the effect of family embeddedness through ownership on earnings management. Our study contributes to corporate governance and family business research by suggesting governance mechanisms to solve socially embedded agency problems in family firms.