Capital Structure, Earnings Management, and Risk of Financial Distress

Family businesses are a leading organizational form in economies all over the world. There is a growing interest around family firms’ financial behavior, in terms of financing and investment choices, performance, and disclosure, as a number of questions are still open. In this chapter we present the literature background and our research questions. Theoretical and methodological choices, structure of the book and target audience are illustrated as well.

This empirical study analyses the effect of family governance on family firms financing behavior. It combines elements of the capital structure theories with the socioemotional wealth approach (SEW), linking the emotional endowment of firm governance and the financing behavior. Using a dataset of 2986 private and listed Italian medium-large firms over the period 2001–2010, we show that family control and influence, as key dimension of the SEW, shapes a firm’s capital structure choices. Multiple family members on the board and in executive positions, generational stage and ownership dispersion explain the results. A multiple presence of family members on the board and in executive positions has a signaling value for creditors. Moreover, we find that family businesses leverage is significantly affected by tangibility, legal structure, firm’s market share and the sensibility to credit restrictions.

This chapter studies leverage’s effect on a firm’s probability of financial distress taking into account different forms of family influence on the business. As family firms are a non-homogeneous group and their governance and management characteristics may impact on risk attitude and financial distress likelihood, we also take into account other measures of risk, board and CEO characteristics, accounting variables and macroeconomic indicators. We address this topic by analyzing a sample of 1137 Italian family and non-family private firms for the period 2004–2013, covering the pre and post financial crisis period. The findings point out that these variables have a different significance in family and non-family firms’ probability of financial distress. Family firms have a lower probability of incurring in financial distress. Leverage has a strong effect for family and non-family firms, but a family’s direct influence on the firm, by appointing a family CEO, has a significant lowering effect on a firm’s probability of financial distress when a family exerts its influence directly.

Earnings management practices are potentially detrimental for stakeholders. Drawing on agency theory integrated with the socioemotional wealth framework we analyze firms’ behavior around equity and bonds issues, comparing family and non-family firms’ earnings management behavior. The data sample is represented by 226 non-financial listed firms for the period 2006–2015. We provide evidence that, in cases of equity emissions all firms significantly increase this practice, but family firms are less prone than their non-family counterparts to manage reported earnings. We do not find a significant effect in cases of bond issues. Our results suggest that the presence of the founder in management has an opposite effect on family compared to non-family firms’ earnings management practices. In family firms, it significantly moderates this unethical behavior and the effect of the founder on earnings quality does not change in case of equity issues, while the effect is negative for non-family firms.

We address the question of the value relevance of earnings management practices. Using a sample of 239 non-financial listed firms for the period 2007–2015 and drawing on the agency theory integrated with the socioemotional wealth framework we study the effect of earnings quality on a firm’s market value. Equity and bond issues are accounted for and we control also for the effect of corporate social responsibility (CSR) disclosure. The results suggest that family and non-family firms’ market value is related to different drivers. Earnings management practices have a significant negative effect on non-family firms’ market value whilst they do not affect family firms’ value in a significant way. We provide also empirical evidence of a significant positive relation between voluntary non-financial disclosure and market value, but this is true only for family firms. The influence exerted by families in terms of founder presence in management, family CEO and family members on the board does not seems to have an impact on firms’ market value.

This book focuses the effect of family control and influence on some aspects of family firms’ financial behavior. The first chapter introduces the theoretical framework, literature overview and the research questions. The second chapter analyzes the effect of family members’ affective endowments on a firm’s leverage. The third chapter studies the effect of leverage on a company’s likelihood of financial distress, pointing out the moderating effect of the owning family’s involvement in the business. The fourth chapter addresses the issue of family firms’ earnings management practices around equity and bond issues whilst the fifth chapter analyzes the effect of disclosure quality on a firm’s market value, taking into account equity and bond issues. This chapter concludes the book, providing an overview of the research, pointing out the main implications and contribution. It also discusses the limitation of our work and provides suggestions for further advances.