Earnings management around founder CEO reappointments and successions in family firms

• Published date: 01 November 2021
• Author: Iram F. Ansari,Marc Goergen,Svetlana Mira
• Date: 01 November 2021
• DOI: http://doi.org/10.1111/eufm.12307

Eur Financ Manag. 2021;27:925–958. wileyonlinelibrary.com/journal/eufm

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DOI: 10.1111/eufm.12307

ORIGINAL ARTICLE

Earnings management around founder CEO

reappointments and successions in family

firms

Iram F. Ansari

1

|Marc Goergen

2,3

|Svetlana Mira

4

1

College of Economics and Political

Science, Sultan Qaboos University,

Muscat, Oman

2

IE Business School, IE University, Madrid,

Spain

3

European Corporate Governance Institute

(ECGI), Brussels, Belgium

4

Cardiff Business School, Cardiff

University, Cardiff, UK

Correspondence

Svetlana Mira, Cardiff Business School,

Cardiff University, Aberconway Bldg.,

Colum Dr., Cardiff, CF10 3EU,

United Kingdom.

Email: MiraS@cardiff.ac.uk

Abstract

This paper studies reappointment of a chief ex-

ecutive officer (CEO) and succession events in

listed family firms with an incumbent family CEO.

We explore whether family firms with a founder

CEO are more likely to engage in earnings man-

agement preevent than other family firms. We find

evidence of preevent upward earnings manage-

ment for firms that reappoint their founder CEO

but no for other family firms. These findings

suggestthatthecostsandbenefitsfromearnings

management change around founder CEO re-

appointments in family firms. Investors, auditors,

policymakers and regulators should be aware of

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use, distribution and

reproduction in any medium, provided the original work is properly cited.

© 2021 The Authors. European Financial Management published by John Wiley & Sons Ltd.

We would like to express our thanks to John Doukas, the Editor, as well as two anonymous reviewers for their support

and constructive feedback on earlier versions of our paper. We are also very grateful to Michelle Hanlon, who com-

mented extensively on an early draft of this paper. We have benefitted from comments made by Peter Easton, parti-

cipants at seminars at Cardiff Business School and the College of Economics and Political Science, Sultan Qaboos

University, as well as participants at the 16th Workshop on Corporate Governance and Investment, Alliance Man-

chester Business School, the 2019 Annual Conference of British Accounting and Finance Association SWAG, the 2020

European Corporate Governance Institute—Stockholm School of Economics Conference on SMEs, Families and Ca-

pital Markets, and the 6th International Research Forum on Mittelstand, at the University of Mannheim.

the temptation of founder CEOs to inflate earnings

preceding their reappointment.

KEYWORDS

earnings management, family firms, founders, socioemotional

wealth, CEO turnover, CEO successions

JEL CLASSIFICATION

G32; G34; M41

1|INTRODUCTION

Though the literature on earnings management is extensive and mature, Burgstahler and Chuk

(2017, p. 741) nevertheless identify ‘[a] potentially important area for future research [which] is

exploration of changes over time in costs and benefits of earnings management to meet

benchmarks’. Using an international sample of listed family firms from France, Germany and

the United Kingdom that reappoint or replace their incumbent family chief executive officer

(CEO) between 2001 and 2016, we explore earnings management 2 years before and up to

2 years after the event (i.e., the reappointment or the replacement of the incumbent family

CEO). Hence, de facto our period of study spans from 1999 to 2018. We argue that the re-

appointment or replacement of an incumbent family CEO represents a natural breaking point

where the costs and benefits of earnings management to meet benchmarks are likely to be

significantly different as the family is at a crossroads facing two choices.

1

First, the family can

turn its firm into a firm managed by a professional nonfamily CEO, likely combined with

gradual divestment by the family—or to the very least the emergence of an arm's length

relationship between the family and the firm. Second, the family can maintain the status of a

family firm, that is, a firm managed and monitored by successive generations of the family.

On the basis of the above, we argue that the costs and benefits of family firms to engage in

earnings management change around founder CEO reappointments. Prior evidence (e.g., Gómez‐

Mejía et al., 2007,2011) show that family firms are unique entities that behave differently because of

the socioemotional wealth the controlling/founder family holds in the firm. Socioemotional wealth

refers to the pursuit by family firms of objectives other than purely financial objectives. Hence, we

maintain that founder CEOs who opt for reappointment, given their greater socioemotional at-

tachment to their firm than later‐generation family CEOs, engage in earnings management to

report good performance in the year preceding their reappointment. This ensures that the minority

shareholders are less likely to oppose the family's ongoing control and management of the firm,

allowing the incumbent family founder CEO to pursue their vision of the firm. Though we cor-

roborate prior evidence that overall family firms practice less earnings management than nonfamily

firms (e.g., Martin et al., 2016), we also find evidence of upward earnings management when a

1

Prior studies identify other instances of natural breaking points where the controlling shareholder has incentives to

manage earnings. Hou et al. (2015), for example, find that Chinese firms with a controlling shareholder entering into

performance commitment contracts manages earnings upward to achieve the prespecified performance target when

actual performance falls short. This suggests that, supporting the more general argument put forward by Burgstahler

and Chuk (2017), firms with a controlling shareholder have incentives to use earnings management to achieve

benchmarks and these incentives are only temporal.

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founder CEO is reappointed. More specifically, we find that actual accruals deviate from predicted

accruals in the preevent year by an additional 4.8 percentage points of total assets in family firms

that reappoint their founder CEO when compared to family firms that appoint a nonfamily CEO.

Following Jones (1991), Healy and Wahlen (1999), Dechow et al. (2003), Ball and Shiva-

kumar (2005), we define accrual‐based earnings management as changes made to reported

earnings via discretionary accruals by the insiders to mislead certain stakeholders or to affect

contractual outcomes.

2

Focusing on accrual‐based earnings management in family firms, and

comparing different types of events in family firms, our paper makes the following four con-

tributions to the extant literature.

First, to the best of our knowledge, this is the first study to show that the costs and benefits

from earnings management change around founder CEO reappointments in family firms. We

corroborate prior evidence that family firms engage in less accrual‐based earnings management

than nonfamily firms (Martin et al., 2016). Yet, the key and novel contribution of this study is

that founder CEOs coming up for reappointment inflate earnings upwards more than other

family CEOs in the year preceding their reappointment. Importantly, whereas Martin et al.

(2016) find that overall founder family firms are less likely to engage in earnings management,

we show the exact opposite pattern applies to founder family firms whose founder CEO is up for

reappointment.

3

This finding is in line with prior literature suggesting that founder firms are

different from other firms when it comes to financial misconduct. For example, Andersons et al.

(2017) find that the incidence of SEC enforcement actions is nearly three times greater in family

firms than in matched nonfamily firms. They also document that founder CEOs account for

nearly 71% of enforcement actions. Furthermore, Amiram et al. (2018) conclude that the reg-

ulators appear to under‐target founder firms. In line with this evidence in the field, we show for

the first time that founder CEOs in family firms inflate earnings upwards in the year preceding

their reappointment. Hence, investors in family firms, as well as internal and external auditors,

policymakers and regulators should be aware of the temptation of founder CEOs to engage in

upward earnings management preceding their reappointment.

Second, and more generally, the paper adds to the literature on earnings management

around CEO turnover, a literature, which as yet disagrees about the effects of outgoing and

incoming CEOs on earnings management. We find that founder CEOs in family firms manage

earnings upward in the year before coming up for reappointment more than other CEOs. Again,

for the first time, we show that it is important to differentiate between the types of outgoing and

incoming CEOs.

Third, to date, both the theoretical and empirical literature disagrees as to the effects of

family control and ownership on earnings management. Theory predicts that there are two

competing effects of concentrated ownership and control—and family ownership and control

more specifically—on earnings management: the entrenchment effect and the alignment effect.

According to the entrenchment effect, large shareholders—such as families—extract private

benefits of control from their firm. Manipulating reported earnings is one way of extracting

such benefits. Hence, earnings management should be greater and earnings quality should be

2

Real earnings management is an alternative type of earnings management (e.g., Jones, 1991) and it consists of

manipulating reported earnings via changing the timing and scale of various real transactions (e.g., Roychowdh-

ury, 2006). In an earlier version of the paper, we considered both, accrual‐based and real earnings management. In line

with Achleitner et al. (2014), we find that family firms engage to a lesser extent in real earnings management than

accrual‐based earnings management yet reappointed founder CEOs inflate earnings via both types of earnings

management.

3

Importantly, 60% of our family firms have a founder CEO.

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