Board independence and earnings management: influence of family business generation
| DOI | https://doi.org/10.1108/JABS-07-2020-0280 |
| Published date | 26 July 2021 |
| Date | 26 July 2021 |
| Pages | 748-768 |
| Author | Manish Bansal |
Board independence and earnings
management: influence of family
business generation
Manish Bansal
Abstract
Purpose –This study aims at investigating the moderating role of family business generation on the
associationbetween board independence andearnings management practices of Indianfamily firms.
Design/methodology/approach –This study uses panel data regressionmodels to analyze the data.
Board independence is operationalized via the proportion of independent directors on board and the
dual role of chief executive officer. Earnings management is operationalized through discretionary
accruals, which are estimatedby the performance-adjusted modified Jones model(Kothari et al.,2005).
Family business generationis based on the firm’s age, where each generationis equated to a period of
25 years. The parameters of interest are estimated through the hybrid model (Allison, 2009) which
controls for the unobservedcross-sectional heterogeneity across firms whileestimating the coefficients
for time-invariantvariables.
Findings –Based on a sample of 26,962Bombay Stock Exchange–listed firm-years,spanning over 13
years from the year ending March 2007to March 2019, the results exhibitthat Indian family firms are less
likely to be engaged in earnings management; board independence is ineffective in controlling the
earnings managementpractices of firms, and this relation is found to be more pronouncedamong family
firms; first-generationfamily firms are more likely to be engagedin earnings management than second- or
third-generationfirms; and board independence has a weakerrole in curbing the earnings management
practices of first-generation family firms. Overall, the results exhibit that generational involvement
significantly influencesthe association between family firms and earnings management and moderates
the relationship between board independence and earnings management. These results are robust to
sensitivitymeasures.
Originality/value –This is the first study that examines the moderating impact of family business
generationon the association between board independenceand earnings management according to the
author’s knowledge.Besides, this is among the earlier attemptsto investigate the earnings management
practicesof Indian family firms.
Keywords India, Earnings management, Family firms, Board independence, Business generation
Paper type Research paper
1. Introduction
A vast amount of research has documentedthe mitigating effect of the board of directors on
agency problems (Benkel et al.,2006;Dechow et al., 1996;Peasnell et al.,2005). One such
widely explored evidence of agency problems is the earnings management behavior of
managers. Earnings management refers to the practice under which managers maximize
the pursuance of self-interests or justify the performance effects of their opportunistic
behavior by the way of altering the accounting numbers (Aliet al.,2007). Hence, a board of
directors is considered a key constraining mechanism on earnings management.
However, the evidence of the impact of board characteristics on earnings management is
scant in the context of family firms. The board’s independence is lower among family firms
Manish Bansal is based at
the Department of
Accounting and Finance,
Indian Institute of
Management Ranchi (IIM
Ranchi), Ranchi, India.
Received 14 July 2020
Revised 29 September 2020
11 October 2020
Accepted 13 October 2020
The author thank Professor K.N.
Badhani, Indian Institute of
Management Kashipur, India
for his assistance in the
methodology section of this
paper.
PAGE 748 jJOURNAL OF ASIA BUSINESS STUDIES jVOL. 15 NO. 5 2021, pp. 748-768, ©Emerald Publishing Limited, ISSN 1558-7894 DOI 10.1108/JABS-07-2020-0280
due to the dominance of family members on board. The impact of independent directors
and chief executive officer (CEO) non-duality on earnings management is found to be
weaker for family firms due to the increased risk of outsider director’s collision with the
dominant family (Jaggi et al., 2009;Prencipe and Bar-Yosef, 2011). It indicates that the
board of directors is less effective in performing its monitoring role in family firms than in
nonfamily firms.
Although family firms have weaker corporate governance, yet they are found to outperform
their nonfamily counterparts in terms of sales, profits and other growth measures (Klein
et al., 2005). Family businesses have an edge over their competitors in terms of financial,
labor and intellectual resources, consistent with the resource-based view of family firms
(Barney, 1991). Their specific strengths make them more profitable and valuable than
nonfamily counterparts even under weak governance practices (Cadbury, 2002). These
strengths include commitment, knowledge continuity and a sense of reliability. The
commitment shown by the family owners is probably much more than an employee would
have over the business. As family businesses get handed over from generation to
generation, the institutional memory and continuity are way more than that of their
counterparts. All the accumulated knowledge, experience and skills are passed on to the
next generation on priority. Besides, confidence, sense of reliability and faith among the
stakeholders are higher for family firms due to the sense of pride attached to the family
name.
The governance literature has shown that the relationship between board characteristics
and earnings management is moderated by the potential presence of agency conflicts
indicating that the monitoring role of the board is conditional (Chi and Lee, 2010). So, a
possible explanation for the discrepancy in the effectiveness of the board in performing its
control task in family firms is that prior studies have not taken this conditional aspect into
account. Hence, not controlling the conditional nature of the influence of board
characteristics is likely to be the reason behind the failure to detect the significant relation
between board independence and earningsmanagement among family firms.
Therefore, this study aims to advance the understanding of the role and contribution of
independent directors and the separation of CEO and board chair roles in constraining
earnings management in family firms by examining the conditional nature of family firms.
The stage in which the firm is operating is found to be a significant factor affecting the role
of board independence (Jaffe and Lane, 2004). Research documented that first-generation
firms prioritize the family objectives over business objectives (Westhead, 2003), and this
priority is found to be reversed when the second or third generations take over the
ownership of the firm (Van Gils et al., 2004). Hence, it is likely that role of board
independence in curbing earnings management practices is different for first- and second-
or later-generation firms. Accordingly, this study examines the relationship between board
independence and earnings managementconditional on (moderated by) the stage in which
the firm is operating.
The current study focuses on an emerging market, India, which is characterized by weaker
corporate governance mechanisms, lax legal enforcement and lower investor protection
regimes (Narayanaswamy et al.,2012). Further, the Indian corporate landscape is
dominated by family-owned andcontrolled firms (Villalonga and Amit, 2006). Consequently,
there is evidence that Indian firms engage in earnings management (Sarkar et al., 2008;
Shette et al.,2016). Besides, board independence has a statutory backup in India. For
instance, Section 149 of Companies Act 2013 mandates for the listed firms to have at least
one-third of the board of directors as independent directors, and Section 203 restricts the
dual role of CEO.
Besides, to the best of our knowledge, there has been no study to date that examines the
earnings management practices of family firms operated in India, where more than 70% of
VOL. 15 NO. 5 2021 jJOURNAL OF ASIA BUSINESS STUDIES jPAGE 749
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