Earnings Management Goes Familial

In the German institutional context, family firms engage less in real earnings management (REM), and more in earnings decreasing accrual-based earnings management (ABEM) than non-family firms. Moreover, family firms treat these two types of earnings management as substitutes rather than complements. Thus, family firms avoid earnings management strategies that might endanger the firm's long term value (i.e. REM), and seek to use those that help firms to keep control of the firm within the family across successive generations (i.e. ABEM). Together, these findings can be seen as evidence that family firms make decisions not only with economic performance in mind, but also with how they affect the decision maker's personal life and that of the family (i.e. socio-emotional wealth).

Gianfranco Siciliano (Department of Accounting) and his coauthors, Ann-Kristin Achleitner, Nina Günther, and Christoph Kaserer,concluded this from a series of empirical analyses run on a sample of 402 family and 436 non-family firms listed in Germany during 1998-2008. They report these findings in an article called "Real Earnings Management and Accrual-based Earnings Management in Family Firms", which will soon be published in the European Accounting review.

The authors find that family firms are less likely than other firms to use real earnings management, which sacrifices future revenue streams for current income. This finding was expected, since family firms are likely to be more concerned than non-family firms with the long term value of the firm. Increasing the long term value will ensure that generations to benefit from the firm as well. On the other hand, family firms are more likely than non-family firms to use earnings decreasing ABEM. This earnings management strategy provides conservative estimates of earnings and retains value within the firm, reducing pressure to increase dividends, and thus allowing the family to invest more money in the firm. Lastly, the authors find that family firms choose to do either REM or ABEM, but not both. Especially when they pursue REM to an extreme extent, they are less likely also to use ABEM.

These results might be important for shareholders and scholars. They might help shareholders decide whether to invest in family firms. In fact, family firms are more likely than other firms to understate their accruals, and less likely to divert from their regular business model to get returns earlier rather than later. Such firms might thus be more suitable for long-term rather than short-term investment. These results might also advance scholarly work by investigating how family firms determine and trade off their REM and ABEM strategies.