Sustainable Development of Chinese Family Firms: A Perspective from Downward Earnings Management before Successions

Abstract

Most initial entrepreneurs of Chinese family firms are approaching retirement, and intra-family successions have occurred frequently in recent years. However, both founders and the public have concerns about successors’ ability of assuming the responsibility of long-term sustainable development of their family business. This paper aims to explore whether and how founders manage earnings before within-family successions for the purpose of smooth successions. Based on a sample of Chinese family firms from 2004 to 2018 and using the ordinary least square (OLS) regression method, this study finds that Chinese family firm founders tend to manage earnings downward in the year before they transfer business to their heirs. Furthermore, founders with poverty experiences and political connections have more incentives to manipulate earnings downward. Firms’ institutional investors and the legal environment inhibit founders’ earnings management behavior before within-family successions, but independent directors do not have any significant impact on the association between successions and earnings management. Finally, it is documented that the downward earnings management leads to more favorable market reactions in the short term but do harm to firms’ long-term sustainable development. The results are robust to the Heckman two-stage analysis and using the alternative measures of earnings management. This study contributes to research on family firm succession and earnings management, and is also informative to policy makers, market participants, and family firm founders.