Abstract:
This paper examines the effects of controlling shareholder (“CS”) characteristics on financial reporting conservatism. This study extends the Basu (1997) model to examine the link between accounting conservatism and controlling shareholder characteristics by incorporating the ownership proxies into the model. Controlling shareholder characteristics can be divided into two: i) founding family (“FF”) firms, and ii) family (“FAM”) firms. Since the alignment effect is likely to be more severe in FF firms, as FF Firms are more likely to pass on their business to future generation and to protest the family’s reputation, this study hypothesizes that increasing in FF member ownership is positively associated with accounting conservatism (or higher earnings quality), ceteris paribus. Conversely, the entrenchment effect is likely to be more severe when the interest of FAM and of minority shareholders are less aligned as FAM firms might not take responsibility for the firm’s early growth and development. Thus, FAM member ownerships are expected to be negatively associated with accounting conservatism. Consistent with the above hypotheses, this study finds that conservatism, as measured by asymmetric timeliness of earnings, increases with greater controlling shareholder ownership in FF firms, while at the same time conservatism decreases in FAM firms. This study also examines CEO characteristics (founder, descendent or hired outsider) in FF and FAM firms. In FF firms, founder, descendent, and hired outsider CEOs are associated with more conservatism, while only descendant CEOs in FAM firms are associated with less conservatism. Moreover, this study also examines politically connected firms and accounting conservatism and documents that politically connected FF firms are associated with less conservatism. The results also hold after controlling for control variables established in prior work to be related to corporate governance and firm characteristics. Overall, this study provides empirical evidence for conservatism based on controlling shareholder characteristics.
