4. Accounting Conservatism in Family Firms

The other concepts usually associated with reliability are faithfulness, verifiability, and neutrality.

Auditors may also concur in incentivizing conservative accounting. Their legal liability may favour a more conservative accounting in order to mitigate the risk of lawsuit against their decisions. For instance, a “lowering-of-cost-or market” approach reduces auditor liability, leading to a more conservative set of choices in terms of measurement.

Another measure of accounting conservatism used in the literature is based on three years average of non-operating accruals (Chen et al. 2014; Givoly and Hayn 2000). This measure captures the movement of items such as item restructuring charges, the impact of changes in estimates, and asset write-downs. Higher values of non-operating accruals indicate more conservative accounting. This approach does not make a distinction between conditional and unconditional conservatism. We adapt this model to the study of family firms as follows:

where:

NACC = Non-operating accruals, measured as the difference between total accruals and operating accruals scaled by total assets.

All other variables are as defined in Sect. 4.5.1.

A positive (negative) and significant coefficient L₁ of the variable FF indicates that family firms are more (less) conservative compared to non-family firms.

Past research also computes the difference in the skewness of earnings and cash flows to measure accounting conservatism (Beatty et al. 2008; Givoly and Hayn 2000). More conservative firms exhibit a greater left-skewness in the distribution of earnings compared to the distribution of cash flows. This ratio is the result of firms’ conservative decisions to have large negative charges reflecting bad news.

The literature highlights other critical structural issues which may affect the results computed with the Basu (1997) model (Gigler and Hemmer 2001; Wang 2006). Firstly, the results might be biased due to the absence of control for voluntary disclosures on stock price. Secondly, it does not distinguish between the transitory components in earnings from random accruals errors, and it cannot detect whether transitory loss components in earnings are timely recorded. To mitigate the concerns related to the serial dependence model, researchers could consider looking at the contemporaneous association between short-window stock returns surrounding earnings announcement and the transitory components in earnings (Wang 2006). Finally, another limitation of this model is represented by the fact that L₁ is equal to 1 for bad news. However, during recession periods, e.g., the recent financial crisis, this model does not work, since the share price and net income for all companies goes down. To overcome this problem, a potential solution is to look at abnormal returns comparing companies’ returns to stock market returns (André et al. 2015).

Chapter 2 discusses the different ways to empirically measure family firms.

See Chap. 5 for further discussion about disclosure in family firms.

Consistent with Frank et al. (2009), we define tax aggressiveness as the firm’s attitude to making decisions aimed at reducing the taxes paid on profit.

Desai and Dharmapala (2006) and Desai et al. (2007) extensively discuss the complementary relation between tax avoidance and rent extraction.

The authors refer to the following family firm definition by Habbershon et al. (2003), “the idiosyncratic firm level bundle of resources and capabilities resulting from the systems interactions”.