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Family Control, Socioemotional Wealth and Earnings Management in Publicly Traded Firms

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Abstract

We examine the unique nature of agency problems within publicly traded family firms by investigating the earnings management decision of dominant family owners relative to non-family. To do so, we draw upon literature demonstrating that family owners are loss averse with respect to the family’s socioemotional wealth, or the affective endowment derived from firm ownership and control. Our theory and findings suggest that potential reputational consequences of earnings management lead family principals to engage in less of this practice relative to non-family firms, and that founder family firms are less likely than non-founder family firms to use earnings management. Moreover, the family-firm effect varies with the firm size, the degree of CEO entrenchment, and the firm’s stock structure. We provide important insights regarding differences between family and non-family principals in the use of unethical accounting practices, thereby extending agency theory and advancing an underdeveloped research area.

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Notes

  1. A higher level of earnings management (that is, more aggressive) is, therefore, the use of judgment in financial reporting (such as the use of accruals) to inflate reported profits (or reduce losses) in the extreme.

  2. Extant literature generally defines a dominant shareholder as one with at least 5 % of outstanding stock. Our definition of a family firm is consistent with this ownership threshold.

  3. Larger investors may sell down their holdings over periods of time in order to avoid the negative price effects of selling large blocks of shares (Griffin et al. 2003).

  4. Stockmans et al. (2010), using a sample of Flemish firms, find that earlier generations of the family firm will be more likely to use earnings management. They argue that earlier generations are more strongly motivated to preserve SEW, yet suggest that this leads to more earnings management. We contrast this approach by arguing that the reputational effect of earnings management upon socioemotional wealth leads to the opposite prediction: less earnings management by founders (i.e., earlier generations).

  5. This is consistent with March and Simon (1958) argument that inducements within organizations lead to greater contributions by those employees receiving the inducement.

  6. The use of discretion by management in determining accruals is generally lawful and thus falls under the definition of earnings management in the extant literature. However, there will be situations where accruals are used outside of the limits of the GAAP and thus fall under the definition of earnings manipulation.

  7. The results are substantively unchanged if we use the areg panel estimation procedure.

  8. The exception is Stockmans et al. (2010), who have applied socioemotional wealth to the study of CEO decision making in the earnings management decision (as opposed to the role of the family owners as dominant shareholders) with a focus upon how generational differences influence CEO earnings management within family firms.

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Martin, G., Campbell, J.T. & Gomez-Mejia, L. Family Control, Socioemotional Wealth and Earnings Management in Publicly Traded Firms. J Bus Ethics 133, 453–469 (2016). https://doi.org/10.1007/s10551-014-2403-5

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