DA is included as one of the independent variables of REM in Equation 5, while REM is one of the independent variables of DA in Equation 6. Therefore, DA and REM are simultaneously both dependent and independent variables to each other. In other words, this is a scenario in which the errors (residuals) from Equations 5 and 6 are correlated, because all values of the variables are collected from the same set of observations. To solve this simultaneous situation, this study uses a seemingly unrelated regression to re-run Equations 5 and 6.
Table 9
Regression: Instrumental variable in the two-stage least squares (IV-2SLS) regression (N=1,263)
***, ** and * indicates significance at the 1 percent, 5 percent and 10 percent levels, respectively.
Table 10
Regression: Seemingly unrelated regression for Equation 5 and Equation 6
Equation 5 (N=2,354) Equation 6 (N=1,263) Variable Parameter
Estimate Z Value Parameter
Estimate Z Value
***, ** and * indicates significance at the 1 percent, 5 percent and 10 percent levels, respectively.
Table 10 presents the regression results by employing a seemingly unrelated regression. The empirical results support H2 and H3, but not H4, which are consistent with previous findings from this study.
5. Conclusions
From Tables 4 to 10, the empirical results of this study are mostly consistent and support H1, H2, and H3, but not H4. This shows that for a family firm with an earnings management incentive, because the risk of being supervised is low (Goh et al., 2014; Hsu et al., 2013) and because family members’ wealth is closely tied to the value of the company, family members will reduce behaviors that can harm the value of their company for the good of its long-term reputation (Anderson and Reeb, 2003a, 2003b; Gomes, 2000;
Miller et al., 2007; Weber et al., 2003). Therefore, they tend not to use the “real earnings management” mechanism, which can hurt the value of the company, but instead prefer to use the “accruals management” mechanism. Hence, the first contribution of this study is to find out which type of earnings management mechanism a family firm chooses to engage in, which can serve as a reference for regulators.
Inside directors possess private information that they can share with other directors in order to reduce information asymmetry among them. Since each inside director has private information, the board of directors has an internal balancing power that can be used to test the authenticity of the internal information shared by internal directors (Tai et al., 2015), thus reducing the possibility of incorrect information transfer. As a result, if the proportion of inside directors is higher in a family firm, then because of the reduction of information asymmetry, the family firm will be less likely to engage in accruals management. Hence, the second contribution of this study is determining that increasing the proportion of insider directors and bringing together all private information are ways for family firms to reduce the likelihood of engaging in accruals management.
Neither of the empirical results shows that a family firm will significantly reduce accruals management behavior if it pays a higher inside director’s compensation for the role of director, whether using the proportion of an inside
director’s compensation for their role as director or the natural logarithm. A possible reason for this finding is that in this study the mean of the proportion of an inside director’s compensation for the role as director (BS) is about 0.3, and during the period of this study, the annual reports do not record stock compensation for the manager role. Therefore, if stock compensation for the manager role is further considered, then the proportion of an inside director’s compensation for the role of director will be even lower. According to the agency theory, compensation should be an increasing function of performance (Hölmstrom, 1979), and so when a company mostly gives inside directors managers’ compensation, inside directors tend to perform the executive functions of a manager more, and fewer of the supervisory functions of the director role. This led to this study’s empirical results that show that the directions of coefficients are as expected but did not have statistical significance.
To summarize the empirical results of this study, because a family firm’s risk of being supervised is low (Goh, Rasli, and Khan, 2014; Hsu et al., 2013), information asymmetry is more serious. Moreover, because of the close connection between family members’ wealth and the value of the company, family members will reduce behaviors that can harm the value of the company for the sake of its long-term reputation (Anderson and Reeb, 2003a, 2003b;
Gomes, 2000; Miller et al., 2007; Weber et al., 2003). Therefore, in the presence of the earnings management incentive, a family firm will choose the “accruals management” mechanism rather than the “real earnings management”
mechanism.
In summary, corporate governance regulations can detect earnings management operations (Huang et al., 2014), and so if the authorities decide to suppress the reduction of earnings management behavior by family firms, then it can follow the method of reducing the “accruals management” mechanism by improving the information disclosure quality and quantity, thus making information transparency clearer and reducing information asymmetry (Chang and Fang, 2006). This study also tests two inside director characteristics that may inhibit a family firm from engaging in accruals management: increasing the proportion of inside directors and increasing the proportion of an inside director’s compensation for the role as director. The empirical results show that inside directors can share private information and reduce information
asymmetry among each other, thus reducing the likelihood of adopting accruals management. However, because an inside director’s compensation for the role as director is lower than that for the role as manager, the incentive for inside directors to share private information is not strong. On the contrary, if the proportion of inside directors is increased, then the accumulation of more individual inside directors’ private information constitutes a workable way to inhibit a family firm from engaging in accruals management.
This study has some limitations. For example, the purpose of this study is to investigate which type of earnings management mechanism a family firm chooses to engage in. Therefore, this study does not test the reasons behind that choice. A firm’s internal resources, external resources, and external environment all affect firm performance (Han et al., 2012). As a result, this research recommends that future studies explore why family firms are more likely to engage in accruals management than in real earnings management.
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